2019-27207
[Federal Register Volume 84, Number 246 (Monday, December 23, 2019)]
[Proposed Rules]
[Pages 70446-70462]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-27207]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 50
RIN 3038-AE92
Exemption From the Swap Clearing Requirement for Certain
Affiliated Entities--Alternative Compliance Frameworks for Anti-
Evasionary Measures
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is proposing revisions to the Commission regulation that exempts
certain affiliated entities within a corporate group from the swap
clearing requirement under the applicable provision of the Commodity
Exchange Act (CEA or Act). The revisions concern the anti-evasionary
condition that swaps subject to the clearing requirement entered into
with unaffiliated counterparties either be cleared or be eligible for
an exception to or exemption from the clearing requirement.
Specifically, the revisions would make permanent certain temporary
alternative compliance frameworks intended to make this anti-evasionary
condition workable for international corporate groups in the absence of
foreign clearing regimes determined to be comparable to U.S.
requirements.
DATES: Comments must be received on or before February 21, 2020.
ADDRESSES: You may submit comments, identified by RIN 3038-AE92, by any
of the following methods:
CFTC Comments Portal: http://comments.cftc.gov. Select the
``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above. Please submit your comments using only one of these
methods. Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (FOIA), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Sec. 145.9 of the Commission's
regulations.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR chapter I.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the FOIA.
FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Deputy Director,
Division of Clearing and Risk, at 202-418-5684 or [email protected];
Melissa A. D'Arcy, Special Counsel, Division of Clearing and Risk, at
202-418-5086 or [email protected]; or Stephen A. Kane, Office of the
Chief Economist, at 202-418-5911 or [email protected], in each case at the
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Overview of Existing Practice
B. Swap Clearing Requirement
C. Commission Regulation 50.52
D. Outward-Facing Swaps Condition
E. Alternative Compliance Frameworks
II. Proposed Amended Regulation 50.52
A. Proposed Revised Alternative Compliance Frameworks
B. Commission's Section 4(c) Authority
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
1. Statutory and Regulatory Background
2. Considerations of the Costs and Benefits of the Commission's
Action
3. Costs and Benefits of the Proposed Rule as Compared to
Alternatives
4. Section 15(a) Factors
D. General Request for Comment
E. Antitrust Considerations
I. Background
A. Overview of Existing Practice
This proposed rulemaking addresses the compliance requirements for
market participants electing not to clear inter-affiliate swaps under
Commission regulation 50.52. This regulation permits counterparties to
elect not to clear swaps between certain affiliated entities, subject
to a set of conditions.\2\ These conditions include a general
requirement that each eligible affiliate counterparty clear swaps
executed with unaffiliated counterparties, if the swaps are covered by
the Commission's clearing requirement.\3\
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\2\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21750 (Apr. 11, 2013).
\3\ Commission regulation 50.52(b)(4)(i).
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As adopted in 2013, the regulation also included two alternative
compliance frameworks (Alternative Compliance Frameworks) that allowed
counterparties to pay and collect variation margin in place of swap
clearing for certain outward-facing swaps.\4\ The Alternative
Compliance Frameworks were adopted for a limited time period and
expired on March 11, 2014.\5\ Since that time, market participants have
requested that Commission staff provide relief equivalent to the
Alternative Compliance Frameworks through no-action letters. The
Division of Clearing and Risk (DCR) first provided no-action relief in
2014. DCR issued CFTC Letter No. 14-25 in response to a request from
the International Swaps and Derivatives Association (ISDA) to provide
relief equivalent to the expiring Alternative Compliance Frameworks set
forth in Commission regulation 50.52.\6\ DCR subsequently extended the
no-action relief provided under CFTC Letter No. 14-25 and later
expanded the relief in a series of five additional no-action
letters.\7\
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\4\ Commission regulation 50.52(b)(4)(ii) through (iii)
(discussed in the Federal Register release adopting Commission
regulation 50.52, the Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21750, 21763-21766 (Apr. 11, 2013)).
\5\ 78 FR 21763--21765.
\6\ CFTC Letter No. 14-25 (Mar. 6, 2014).
\7\ CFTC Letter Nos. 14-135 (Nov. 7, 2014), 15-63 (Nov. 17,
2015), 16-81 (Nov. 28, 2016), 16-84 (Dec. 15, 2016), and 17-66 (Dec.
14, 2017), all available at https://www.cftc.gov/LawRegulation/CFTCStaffLetters/index.htm. CFTC Letter No. 17-66 expanded relief to
parties transacting in Australia, Canada, Hong Kong, Mexico, or
Switzerland and extended the relief to the earlier of (i) December
31, 2020 at 11:59 p.m. (Eastern Time); or (ii) the effective date of
amendments to Commission regulation 50.52.
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[[Page 70447]]
In response to a 2017 request for information \8\ seeking
suggestions from the public for simplifying the Commission's
regulations and practices, removing unnecessary burdens, and reducing
costs, commenters asked the Commission to codify the Alternative
Compliance Frameworks.\9\ Among the comment letters received by the
Commission were six comments discussing the Commission's inter-
affiliate exemption, and four of those commenters specifically
requested that the Commission extend the availability of, or codify,
CFTC Letter No. 16-81.
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\8\ See 82 FR 21494 (May 6, 2017) and 82 FR 23765 (May 24,
2017).
\9\ See the Financial Services Roundtable's comments dated Sept.
30, 2017, available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61430 (requesting that the Commission exempt
inter-affiliate swaps transactions from the scope of all swaps
regulations or, as an alternative, codify the no-action relief
provided under CFTC Letter No. 16-81). See the Institute of
International Bankers' comments dated September 29, 2017, available
at: https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61384 (requesting that the Commission codify the
no-action relief granted under CFTC Letter Nos. 16-81 and 16-84, as
well as provide that market participants can presume that the five
percent test (discussed in more detail below) does not apply to
swaps with affiliates located in jurisdictions that have adopted a
clearing requirement). See the Securities Industry and Financial
Markets Association's comments dated September 29, 2017, available
at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61360 (requesting that the Commission eliminate
the outward-facing swap condition to the inter-affiliate exemption
or, as an alternative, codify the no-action relief granted under
CFTC Letter No. 16-81, and eliminate the five percent test). See the
International Swaps and Derivatives Association, Inc.'s comments
dated September 29, 2017, available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61352 (requesting that the
Commission grant relief that is not time-limited that is similar to
the no-action relief provided under CFTC Letter Nos. 16-81 and 16-
84). See also the Commodity Markets Council's comments dated
September 29, 2017, available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61348 (requesting that the
Commission establish a permanent exemption for all inter-affiliate
swaps from the clearing requirement). See also Credit Suisse
Holdings USA's comments dated September 29, 2017, available at
https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61424
(requesting that the Commission exempt all inter-affiliate swaps
from the clearing requirement, so long as the transactions are:
Reported to a swap data repository; centrally risk-managed; and
subject to the exchange of variation margin).
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The Commission preliminarily believes that adopting rules to permit
affiliated entities to comply with revised Alternative Compliance
Frameworks on a permanent basis (in line with the relief granted in
CFTC Letter No. 17-66 and prior letters) will provide legal certainty
to swap market participants and increase the flexibility offered to
counterparties electing not to clear inter-affiliate swaps, while
keeping compliance costs and burdens on market participants low. As a
result, the Commission is proposing to adopt regulatory revisions to
(i) reinstate the Alternative Compliance Frameworks as a permanent
option for certain swaps between affiliated entities in line with the
existing no-action relief under CFTC Letter No. 17-66, and (ii) make
other minor changes to Commission regulation 50.52. In this proposal,
the Commission is not considering any changes with regard to the trade
execution requirement because those are the subject of another ongoing
rulemaking.\10\
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\10\ The Commission previously proposed an exemption from the
trade execution requirement under section 2(h)(8) of the CEA for
swap transactions to which the exceptions or exemptions to the
clearing requirement that are specified under part 50 apply. The
Commission continues to evaluate this proposal as part of its larger
evaluation of the regulatory framework for swap execution
facilities. See Swap Execution Facilities and Trade Execution
Requirement, 83 FR 61946 (Nov. 30, 2018).
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B. Swap Clearing Requirement
Under section 2(h)(1)(A) of the CEA, if the Commission requires a
swap to be cleared, then it is unlawful to enter into that swap unless
the swap is submitted for clearing to a derivatives clearing
organization (DCO) that is registered under the CEA or a DCO that the
Commission has exempted from registration under section 5b(h) of the
CEA. In 2012, the Commission issued its first clearing requirement
determination, pertaining to four classes of interest rate swaps and
two classes of credit default swaps.\11\ In 2016, the Commission
expanded the classes of interest rate swaps subject to the clearing
requirement to cover fixed-to-floating interest rate swaps denominated
in nine additional currencies, as well as certain additional basis
swaps, forward rate agreements, and overnight index swaps.\12\ The
regulations implementing the clearing requirement are in subpart A to
part 50 of the Commission's regulations. Subpart C to part 50 provides
for an exception to, as well as two exemptions from, the clearing
requirement.
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\11\ Clearing Requirement Determination Under Section 2(h) of
the CEA, 77 FR 74284 (Dec. 13, 2012).
\12\ Clearing Requirement Determination Under Section 2(h) of
the CEA for Interest Rate Swaps, 81 FR 71202 (Oct. 14, 2016).
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C. Commission Regulation 50.52
One of the exemptions from the clearing requirement, in Commission
regulation 50.52, provides an exemption for swaps between certain
affiliated entities, subject to specific requirements and conditions
(Inter-Affiliate Exemption).\13\ Two affiliated entities are eligible
to elect the Inter-Affiliate Exemption for a swap if each of the
counterparties meets the definition of ``eligible affiliate
counterparty'' set forth in Commission regulation 50.52(a). The terms
of the exempted swap must comply with a documentation requirement and
be subject to a centralized risk management program.\14\ The election
of the Inter-Affiliate Exemption, as well as how the requirements of
the exemption are met, must be reported to a Commission-registered swap
data repository (SDR).\15\ Finally, as discussed above, the Inter-
Affiliate Exemption generally requires each eligible affiliate
counterparty to clear swaps executed with unaffiliated counterparties
(i.e., outward-facing swaps), if the swaps are covered by the
Commission's clearing requirement and do not otherwise qualify for an
exception to or exemption from the clearing requirement.\16\
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\13\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21750 (Apr. 11, 2013).
\14\ Commission regulation 50.52(b)(2) through (3).
\15\ Commission regulation 50.52(c) through (d).
\16\ Commission regulation 50.52(b)(4)(i) (the ``Outward-Facing
Swaps Condition'').
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The Commission continues to believe that it is necessary to impose
risk-mitigating conditions on inter-affiliate swaps. As the Commission
stated in the Federal Register adopting release issuing the Inter-
Affiliate Exemption, entities that are affiliated with each other are
separate legal entities notwithstanding their affiliation.\17\ As
separate legal entities, affiliates generally are not legally
responsible for each other's contractual obligations. This legal
reality becomes readily apparent when one or more affiliate(s) become
insolvent.\18\ Affiliates, as separate legal entities, are managed in
bankruptcy as separate estates and the trustee for each debtor estate
has a duty to the creditors of the affiliate, not the corporate family,
the parent of the affiliates, or the corporate family's creditors.\19\
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\17\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21752-21753.
\18\ Note, for example, that while Rule 1015 of the Federal
Rules of Bankruptcy Procedure (FRBP) permits a court to consolidate
bankruptcy cases between a debtor and affiliates, FRBP Rule 2009
provides that, among other things, if the court orders a joint
administration of two or more estates under FRBP Rule 1015, the
trustee shall keep separate accounts of the property and
distribution of each estate. See Federal Rules of Bankruptcy
Procedure (2011).
\19\ See In re L & S Indus., Inc., 122 B.R. 987, 993-994 (Bankr.
N.D. Ill. 1991), aff'd 133 B.R. 119, aff'd 989 F.2d 929 (7th Cir.
1993) (``A trustee in bankruptcy represents the interests of the
debtor's estate and its creditors, not interests of the debtor's
principals, other than their interests as creditors of estate.'');
In re New Concept Housing, Inc., 951 F.2d 932, 938 (8th Cir. 1991)
(quoting In re L & S Indus., Inc.). While the concept of
``substantive consolidation'' of affiliates in a business enterprise
when they all enter into bankruptcy is sometimes used by a
bankruptcy court, substantive consolidation is generally considered
an extraordinary remedy to be used in limited circumstances. See
Substantive Consolidation--A Post-Modern Trend, 14 Am. Bankr. Inst.
L. Rev. 527 (Winter 2006).
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[[Page 70448]]
D. Outward-Facing Swaps Condition
The Outward-Facing Swaps Condition requires that an eligible
affiliate counterparty relying on the Inter-Affiliate Exemption clear
any swap covered by the Commission's clearing requirement (i.e., an
interest rate or credit default swap identified in Commission
regulation 50.4) that is entered into with an unaffiliated
counterparty, unless the swap qualifies for an exception or exemption
from the clearing requirement under part 50.\20\ This provision applies
to any eligible affiliate counterparty electing the Inter-Affiliate
Exemption, including an eligible affiliate counterparty located outside
of the United States.
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\20\ Commission regulation 50.52(b)(4)(i). The Outward-Facing
Swaps condition also permits an eligible affiliate counterparty to
clear a swap pursuant to a non-U.S. clearing requirement that the
Commission has determined to be ``comparable, and comprehensive but
not necessarily identical, to the clearing requirement of section
2(h) of the [CEA]'' and to part 50, or to comply with an exception
to or an exemption from a non-U.S. clearing requirement that the
Commission has determined to be comparable to an exception or
exemption under section 2(h)(7) of the CEA and part 50. The
Commission has made no such comparability determination.
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The Outward-Facing Swaps Condition is intended to prevent swap
market participants from using the Inter-Affiliate Exemption to evade
the clearing requirement or to transfer risk to U.S. firms by entering
into uncleared swaps with non-U.S. affiliates in jurisdictions that do
not have mandatory clearing regimes comparable to the Commission's
clearing requirement regime.\21\ Such evasion could be accomplished if
the non-U.S. affiliate enters into a swap with an unaffiliated party
also located outside of the U.S. and that swap is related on a back-to-
back or matched book basis with the swap executed with the affiliated
party located in the U.S.\22\ In the adopting release to the Inter-
Affiliate Exemption, the Commission noted that section 2(h)(4)(A) of
the CEA requires the Commission to prescribe rules to prevent evasion
of the clearing requirement.\23\
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\21\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21760-21762.
\22\ Id. at 21760.
\23\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21761. The Commission also notes that Commission
regulation 1.6 makes it unlawful to conduct activities outside the
United States, including entering into agreements, contracts, and
transactions and structuring entities, to willfully evade or attempt
to evade any provision of Title VII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, including the swap clearing
requirement under section 2(h)(1) of the CEA. Any such evasionary
conduct will be subject to the relevant provisions of Title VII. In
determining whether a transaction or entity structure is designed to
evade, the Commission considers the extent to which there is a
legitimate business purpose for such structure. 77 FR 48208, 48301
(Aug. 13, 2012).
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E. Alternative Compliance Frameworks
1. Background
When the Commission adopted the Inter-Affiliate Exemption, it
provided two Alternative Compliance Frameworks with which eligible
affiliate counterparties located outside of the United States could
comply, until March 11, 2014, instead of complying with the Outward-
Facing Swaps Condition.\24\ These Alternative Compliance Frameworks
were not in the original rule proposal, but the Commission added them
to the final rule in order to address concerns raised by commenters
about the need to align the Commission's Inter-Affiliate Exemption with
clearing regimes in other jurisdictions.\25\ In the proposal, the
Commission did not identify specific jurisdictions for specially-
tailored outward-facing swaps requirements.\26\ Rather, the Commission
proposed a set of conditions that would have required non-U.S.
affiliate counterparties to clear almost all outward-facing swaps.\27\
Recognizing the concerns expressed by commenters,\28\ the Commission
adopted a final rule that gave non-U.S. affiliates more flexibility in
complying with the outward-facing swap requirements. At the time the
Commission adopted its final rule, the Commission expected other
jurisdictions to adopt their own clearing requirements soon thereafter
and determined that an alternative compliance framework was needed for
only twelve months after required clearing began in the United
States.\29\ The Outward-Facing Swaps Condition under Commission
regulation 50.52 was an attempt to balance flexibility for non-U.S.
affiliates with the need to protect against evasion of the Commission's
clearing requirement.
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\24\ Commission regulation 50.52(b)(4)(ii) through (iii)
(discussed in the Federal Register release adopting Commission
regulation 50.52, the Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21763-21766).
\25\ See Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21764.
\26\ See Clearing Exemption for Swaps Between Certain Affiliated
Entities, 77 FR 50423 (Aug. 21, 2012) (proposing regulation
39.6(g)(2)(v)) hereinafter, the ``Affiliated Entities Proposal'').
\27\ The Commission's proposed inter-affiliate exemption would
have required all inter-affiliate swaps with non-U.S. persons to
satisfy one of three conditions: (i) The non-U.S. person affiliate
is domiciled in a jurisdiction with a comparable and comprehensive
regulatory regime for swap clearing, (ii) the non-U.S. person
affiliate is otherwise required to clear swaps with third parties in
compliance with U.S. law, or (iii) the non-U.S. person does not
enter into swaps with third parties. See Affiliated Entities
Proposal, 77 FR 50431 (discussing proposed regulation
39.6(g)(2)(v)).
\28\ ``Notwithstanding the progress of other jurisdictions to
implement their clearing regimes, as discussed above, the Commission
is mindful of commenters' concerns that the compliance timeframe for
the clearing requirement in the U.S. is likely to precede the
adoption and/or implementation of the clearing regimes of most other
jurisdictions.'' Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21764.
\29\ ``The Commission believes that a transition period of 12
months after required clearing began in the U.S. is appropriate
given its understanding of the progress being made on mandatory
clearing in the specified foreign jurisdictions.'' Clearing
Exemption for Swaps Between Certain Affiliated Entities, 78 FR at
21764.
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Under existing Commission regulation 50.52(b)(4)(ii)(A), which
expired on March 11, 2014, if one of the eligible affiliate
counterparties to a swap is located in the European Union, Japan, or
Singapore, either of the following satisfies the Outward-Facing Swaps
Condition:
(1) Each eligible affiliate counterparty, or a third party that
directly or indirectly holds a majority interest in both eligible
affiliate counterparties, pays and collects full variation margin daily
on all swaps entered into between the eligible affiliate counterparty
located in the European Union, Japan, or Singapore and an unaffiliated
counterparty; or
(2) Each eligible affiliate counterparty, or a third party that
directly or indirectly holds a majority interest in both eligible
affiliate counterparties, pays and collects full variation margin daily
on all of the eligible affiliate counterparties' swaps with other
eligible affiliate counterparties.\30\
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\30\ Commission regulation 50.52(b)(4)(ii)(A).
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Under existing Commission regulation 50.52(b)(4)(ii)(B), which
expired on March 11, 2014, an eligible affiliate counterparty located
in the European Union, Japan, or Singapore is not required to comply
with either the Outward-Facing Swaps Condition or the variation margin
provisions of Commission regulation 50.52(b)(4)(ii)(A), provided that
the one counterparty that directly or indirectly holds a majority
ownership interest in the other counterparty or the third party
[[Page 70449]]
that directly or indirectly holds a majority ownership interest in both
counterparties is not a ``financial entity'' under section
2(h)(7)(C)(i) of the CEA and neither eligible affiliate counterparty is
affiliated with an entity that is a swap dealer or major swap
participant, as defined in Commission regulation 1.3.
In both of these provisions, the Commission determined that
eligible affiliate counterparties located in the European Union, Japan,
or Singapore were entitled to special flexibility because it had reason
to believe that those jurisdictions would be moving forward with their
own clearing requirements quickly.\31\ Japan implemented a clearing
regime and adopted a clearing requirement for certain products that was
effective as of November 1, 2012, before the final Inter-Affiliate
Exemption rule was published.\32\ The European Union's over-the-counter
derivatives reform legislation, including a requirement to adopt a
clearing obligation, entered into force on August 16, 2012.\33\ Later
that year, on December 19, 2012, the European Commission adopted
regulatory technical standards relating to the clearing obligation.\34\
However, the European Securities and Markets Authority's first clearing
obligation did not become effective until June 21, 2016. Finally,
although Singapore was expected to make steady progress on its clearing
requirement, it experienced some delays. The Singapore Parliament
passed legislation adopting an over-the-counter derivatives regulatory
regime in 2012,\35\ and the clearing mandate for certain interest rate
swaps became effective on October 1, 2018.\36\
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\31\ The European Union, Japan, and Singapore were included in
Commission regulation 50.52(b)(4)(ii) because they were seen as
having taken ``significant steps towards further implementation'' of
a clearing regime. Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21763.
\32\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21763-21764.
\33\ Regulation (EU) No 648/2012 of the European Parliament and
of the Council of 4 July 2012 on OTC derivatives, central
counterparties and trade repositories.
\34\ Commission Delegated Regulation (EU) No 149/2013 of 19
December 2012 supplementing Regulation (EU) No 648/2012 with regard
to regulatory technical standards on indirect clearing arrangements,
the clearing obligation, the public register, access to a trading
venue, non-financial counterparties, and risk mitigation techniques
for OTC derivatives contracts not cleared by a central counterparty.
\35\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21763.
\36\ See the Securities and Futures (Clearing of Derivatives
Contracts) Regulations 2018, May 2, 2018, available at https://sso.agc.gov.sg/SL-Supp/S264-2018. See also the Monetary Authority of
Singapore's press release, May 2, 2018, available at http://www.mas.gov.sg/News-and-Publications/Media-Releases/2018/MAS-Requires-OTC-Derivatives-to-be-Centrally-Cleared-to-Mitigate-Systemic-Risk.aspx.
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Today, the Commission recognizes that some non-U.S. jurisdictions
are still in the process of adopting their domestic clearing regimes,
some non-U.S. jurisdictions may never implement clearing for swaps, and
a number of non-U.S. regimes vary significantly in terms of product and
participant scope from the Commission's clearing requirement. Given
this reality, and the fact that relief equivalent to the Alternative
Compliance Frameworks has been provided through a series of CFTC staff
letters for over six years, the Commission is proposing amendments that
would codify the relief provided in the CFTC staff letters, make the
Alternative Compliance Frameworks a permanent option for certain swaps
between affiliated entities, and make other minor changes to Commission
regulation 50.52.
2. CFTC Staff Letters Providing Relief Equivalent to the Alternative
Compliance Frameworks
CFTC staff examined and evaluated the swap market's continued
reliance on the Alternative Compliance Frameworks each year following
the Inter-Affiliate Exemption's adoption.\37\ In March 2014, CFTC staff
noted that the clearing mandates in the European Union and Singapore
were not yet effective, and there was no comparability determination
for Japan. CFTC staff issued CFTC Letter No. 14-25 providing relief
equivalent to the Alternative Compliance Frameworks to December 31,
2014.\38\ Later that year, CFTC staff extended the relief again until
December 31, 2015.\39\ CFTC staff continued to extend the availability
of relief equivalent to the Alternative Compliance Frameworks annually
and ultimately issued relief through December 31, 2020.\40\
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\37\ See CFTC Letter Nos. 14-25 (Mar. 6, 2014), 14-135 (Nov. 7,
2014), 15-63 (Nov. 17, 2015), 16-81 (Nov. 28, 2016), 16-84 (Dec. 15,
2016), and 17-66 (Dec. 14, 2017).
\38\ CFTC Letter No. 14-25 (Mar. 6, 2014). The letter noted that
``extending the alternative compliance frameworks until December 31,
2014 may promote the adoption of comparable and comprehensive
clearing requirements. [DCR] also believes that such extensions will
allow for a more orderly transition as jurisdictions establish and
implement clearing requirements and the Commission issues
comparability determinations with regard to those requirements.''
CFTC Letter No. 14-25 (Mar. 6, 2014), at 4.
\39\ CFTC Letter No. 14-135 (Nov. 7, 2014).
\40\ See CFTC Letter Nos. 15-63 (Nov. 17, 2015), 16-81 (Nov. 28,
2016), and 17-66 (Dec. 14, 2017). Pursuant to CFTC Letter No. 17-66,
DCR will not recommend that the Commission commence an enforcement
action against an entity that uses Commission regulation
50.52(b)(4)(ii) or (iii) to meet the requirements of the Outward-
Facing Swaps Condition until the earlier of (i) 11:59 p.m. (Eastern
Time), December 31, 2020, or (ii) the effective date of amendments
to Commission regulation 50.52.
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It also was thought that the Alternative Compliance Frameworks
would be needed only until the Commission issued comparability
determinations with respect to the Commission's clearing requirement
for non-U.S. jurisdictions. However, to date, the CFTC has not issued
any comparability determinations.\41\ Without a comparability
determination, eligible affiliated entities could not elect to comply
with their domestic clearing regime instead of the CFTC's requirements
for the Outward-Facing Swaps Condition as provided for under Commission
regulations 50.52(b)(4)(i)(B) and (D). As a result of this and other
difficulties, market participants have continued to seek relief from
CFTC staff relating to both of the Alternative Compliance
Frameworks.\42\
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\41\ The CFTC continues to monitor and communicate with
regulators in other jurisdictions as they consider and adopt
clearing regimes. See discussion of non-U.S. jurisdictions' clearing
regimes in the Commission's 2016 final rule adopting the expanded
interest rate swap clearing requirement. Clearing Requirement
Determination Under Section 2(h) of the CEA for Interest Rate Swaps,
81 FR 71202, 71203-71205 (Oct. 14, 2016). However, each
jurisdiction's clearing mandate is unique and tailored to its
derivatives markets and its market participants. For example, in
many non-U.S. jurisdictions, the scope of entities subject to a
clearing mandate and the swaps covered by a clearing mandate varies
significantly from the Commission's clearing requirement.
\42\ Letter from the International Swaps and Derivatives
Association, Inc. (ISDA) to the Commission ``Request for Commission
Action--Part 50,'' dated Nov. 14, 2017 (2017 ISDA Letter),
(requesting that the Commission make permanent the relief provided
in CFTC Letter Nos. 16-81 and 16-84, among other things).
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Aside from providing relief equivalent to the Alternative
Compliance Frameworks, CFTC staff also issued relief to market
participants that are transacting in swaps subject to the Commission's
clearing requirement with eligible affiliates in jurisdictions other
than the three identified under regulation 50.52 (the European Union,
Japan, and Singapore). As explained above, in issuing Commission
regulation 50.52(b)(4)(ii), the Commission limited the provision to
swaps with counterparties located in those three jurisdictions because,
at that time, they had established legal authority to adopt, and were
in the process of implementing, clearing regimes.\43\ Once additional
jurisdictions started to adopt clearing mandates, the Commission
monitored their progress and adopted
[[Page 70450]]
an expanded clearing requirement covering additional interest rate
swaps that had been, or were expected to be, required to be cleared in
other jurisdictions.\44\ In the Commission's 2016 clearing requirement
determination, the Commission expanded the clearing requirement to
cover certain fixed-to-floating interest rate swaps denominated in the
Australian dollar, Canadian dollar, Hong Kong dollar, Mexican peso,
Norwegian krone, Polish zloty, Singapore dollar, Swedish krona, and
Swiss franc, as well as specified other interest rate swaps.\45\
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\43\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21764.
\44\ Clearing Requirement Determination under Section 2(h) of
the CEA for Interest Rate Swaps, 81 FR 71202 (Oct. 14, 2016).
\45\ Id.
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Approximately one month after the Commission adopted the expanded
interest rate swap clearing requirement, market participants requested
that the Commission broaden the list of jurisdictions included in the
Alternative Compliance Framework under Commission regulation
50.52(b)(4)(ii).\46\ In response to ISDA's request, DCR issued CFTC
Letter No. 16-84 to provide relief to eligible affiliate counterparties
located in Australia and Mexico on the condition that they comply with
the Inter-Affiliate Exemption using the Alternative Compliance
Frameworks described in Commission regulation 50.52(b)(4)(ii).\47\ DCR
granted the relief with respect to only Australia and Mexico because
the Commission's clearing requirement followed a phase-in compliance
schedule and products denominated in Australian dollars and Mexican
pesos were the first to be subject to the Commission's expanded
clearing requirement.\48\
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\46\ Letter from ISDA to the Commission dated Nov. 16, 2016,
(requesting that certain provisions of the inter-affiliate exemption
be available for swaps executed between U.S. swap market
participants and their affiliated counterparties located in
Australia, Canada, Hong Kong, Mexico, Singapore, and Switzerland).
\47\ CFTC Letter No. 16-84 (Dec. 15, 2016). Regulators in
Australia and Mexico adopted clearing requirements that became
effective in their home countries in April 2016.
\48\ CFTC Letter No. 16-84 (Dec. 15, 2016). The first compliance
date, December 13, 2016, applied to Australian dollar-denominated
fixed-to-floating interest rate swap and basis swaps, as well as
Mexican peso-denominated fixed-to-floating interest rate swaps.
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More recently, ISDA requested that the Commission codify the relief
provided under CFTC Letter Nos. 16-81 and 16-84, because market
participants continue to rely on the relief equivalent to Alternative
Compliance Frameworks under Commission regulation 50.52(b)(4)(ii) and
(iii).\49\ In addition, ISDA requested that the Commission make the
Alternative Compliance Frameworks available in five additional
jurisdictions (for a total of eight) instead of limiting relief to the
three jurisdictions included in Commission regulation 50.52.\50\ The
2017 ISDA Letter requested that both of the Alternative Compliance
Frameworks cover the home jurisdictions of the currencies included in
the Commission's 2016 expanded clearing requirement determination
(Australia, Canada, Hong Kong, Mexico, and Switzerland) because market
participants would be increasing their swaps activity in those
jurisdictions. For example, U.S. market participants and their
affiliated entities would be expected to increase the number and
percentage of their swaps in Mexico once the Commission adopted a
clearing requirement for the Mexican peso, and a greater percentage of
such affiliate's swaps subject to the clearing requirement would be
conducted in Mexico as well. As non-U.S. currencies were added to the
Commission's clearing requirement, market participants were expected to
conduct more inter-affiliate swaps in those currencies and, most
importantly, with affiliates located in the home jurisdiction of those
currencies.\51\
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\49\ 2017 ISDA Letter.
\50\ Id.
\51\ See also CFTC Letter No. 16-84 (Dec. 15, 2016), at 4
(discussing the effect of the Commission's 2016 expanded interest
rate swap clearing determination on entities relying on relief
equivalent to the Alternative Compliance Framework under Commission
regulation 50.52(b)(4)(iii)).
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In CFTC Letter No. 17-66, DCR extended further the availability of
relief equivalent to Commission regulation 50.52(b)(4)(ii) to include
eligible affiliate counterparties located in Australia, Canada, Hong
Kong, Mexico, and Switzerland, so that those counterparties could use
the relief equivalent to the Alternative Compliance Framework under
Commission regulation 50.52(b)(4)(ii) as well.\52\ Once counterparties
were permitted to rely on the Alternative Compliance Framework in
Commission regulation 50.52(b)(4)(ii), they could use that Alternative
Compliance Framework to satisfy the Outward-Facing Swaps Condition,
instead of trying to stay within the limits of the five percent test
under Commission regulation 50.52(b)(4)(iii).\53\ CFTC Letter No. 17-66
permits eligible affiliates in any of the eight jurisdictions to comply
with the Outward-Facing Swaps Condition using relief equivalent to
Commission regulation 50.52(b)(4)(ii) until the letter expires on
December 31, 2020.
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\52\ CFTC Letter No. 17-66 (Dec. 14, 2017). All of the
Commission's 2016 expanded interest rate swap clearing requirements
have now become effective. The last compliance date for Singapore
dollar-denominated fixed-to-floating interest rate swaps and Swiss
franc-denominated fixed-to-floating interest rate swaps was on
October 15, 2018.
\53\ The Commission notes that at this point in time all
jurisdictions that are being considered for inclusion in the text of
regulation 50.52(b)(4)(ii) have established domestic clearing
requirement regimes. Non-U.S. clearing requirements are in force for
all of the eight jurisdictions included in proposed amendments to
regulation 50.52(b)(4)(ii).
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3. Five Percent Limitation for Affiliated Counterparties in Certain
Jurisdictions
Under existing Commission regulation 50.52(b)(4)(iii), which
expired on March 11, 2014, an eligible affiliate counterparty located
in the U.S. could comply with certain variation margin provisions in
lieu of clearing, with respect to a swap executed opposite an eligible
affiliate counterparty located in a non-U.S. jurisdiction other than
the European Union, Japan, or Singapore, so long as a five percent test
was met. According to this test, the aggregate notional value of swaps
included in a class of swaps identified by Commission regulation 50.4
(classes of swaps covered by the Commission's clearing requirement)
executed between an eligible affiliate counterparty located in the U.S.
and an eligible affiliate counterparty located in a non-U.S.
jurisdiction other than the European Union, Japan, or Singapore may not
exceed five percent of the aggregate notional value of all swaps
included in a class of swaps identified by Commission regulation 50.4
that are executed by the U.S. eligible affiliate counterparty. If the
five percent threshold was exceeded, the Alternative Compliance
Framework was unavailable, under existing Commission regulation
50.52(b)(4)(iii), in connection with swaps with eligible affiliate
counterparties located in a non-U.S. jurisdiction other than the
European Union, Japan, or Singapore.
Eligible affiliates in the jurisdictions discussed above have been
granted relief through CFTC staff letters with respect to the
Alternative Compliance Framework under Commission regulation
50.52(b)(4)(ii), but CFTC staff has not issued no-action relief to
remove those jurisdictions from the category of ``other jurisdictions''
contemplated by Commission regulation 50.52(b)(4)(iii). In light of the
Commission's intent to clarify the application of its rules while
maintaining protections against evasion of the clearing requirement,
the Commission is proposing to exclude a number of non-U.S.
jurisdictions from
[[Page 70451]]
the category of ``other'' by listing them in the text of proposed
regulation 50.52(b)(4)(iii), as discussed below.
II. Proposed Amended Regulation 50.52
The Commission proposes to revise the provisions of the expired
Alternative Compliance Frameworks under Commission regulation
50.52(b)(4)(ii) through (iii). The proposed revisions would reinstate
modified Alternative Compliance Frameworks in a manner substantially
similar to the previously adopted provisions. The proposed frameworks
will streamline the provision and simplify the manner by which market
participants comply with the Outward-Facing Swaps Condition. The
proposed regulations are designed to be consistent with the staff no-
action relief that has been available since 2014.
The Commission believes that the revised regulations also would
continue to prevent swap market participants from using inter-affiliate
swaps to evade the clearing requirement or to transfer risk back to
U.S. firms by entering into uncleared swaps in non-U.S. jurisdictions.
In this proposal, the Commission maintains the Outward-Facing Swaps
Condition and is suggesting small revisions to the Alternative
Compliance Frameworks.
The Commission is not seeking to weaken the protections against
evasion of the clearing requirement. For example, as proposed, there
would be no change to the requirement that any swaps that are exempted
from the clearing requirement under the Inter-Affiliate Exemption must
be subject to a centralized risk management program.\54\ All swaps
exempted from the clearing requirement pursuant to the Inter-Affiliate
Exemption will continue to be subject to the reporting requirements
outlined in Commission regulation 50.52(c) through (d) and part 45 of
the Commission's regulations. The Commission relies on these reporting
requirements to monitor the number of entities electing the Inter-
Affiliate Exemption, as well as the number of inter-affiliate swaps for
which the exemption is claimed. Data on the election of the Inter-
Affiliate Exemption is discussed in more detail below \55\ and is
presented as support for the Commission's view that this proposal to
reinstate the Alternative Compliance Frameworks will not increase
opportunities for affiliated entities to evade the clearing
requirement.
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\54\ Commission regulation 50.52(b)(3).
\55\ See discussion regarding SDR data on the number of
counterparties electing the Inter-Affiliate Exemption below.
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A. Proposed Revised Alternative Compliance Frameworks
1. Variation Margin for Swaps With Affiliated Counterparties--In
General
This proposal to revise the Alternative Compliance Frameworks would
permit all non-U.S. eligible affiliate counterparties to comply with
one of the Alternative Compliance Frameworks by paying and collecting
full variation margin daily on all swaps with other eligible affiliate
counterparties. The relevant provisions are in proposed revised
regulation 50.52(b)(4). Paragraph (ii) of this proposed section applies
if at least one of the eligible affiliate counterparties is located in
Australia, Canada, the European Union, Hong Kong, Japan, Mexico,
Singapore, Switzerland, or the United Kingdom, while paragraph (iii) of
this proposed section addresses swaps entered into by eligible
affiliate counterparties in the remaining jurisdictions.
The Commission preliminarily believes that the variation margin
requirement included in both of the revised Alternative Compliance
Frameworks, under proposed revised regulation 50.52(b)(4)(ii) and
(iii), will mitigate the impact of any potential evasion of the
Commission's clearing requirement. Although paying and collecting
variation margin daily does not mitigate counterparty credit risk to
the same extent that central clearing does, the Commission believes, as
stated in the 2013 adopting release for the Inter-Affiliate Exemption,
that variation margin is an essential risk management tool.\56\
Variation margin requirements may prevent risk-taking that exceeds a
party's financial capacity and acts as a limitation on the accumulation
of losses when there is a counterparty default or failure to make
payments. The process of paying and collecting variation margin
accomplishes this by requiring swap counterparties to mark open
positions to their current market value each day and to transfer funds
between them to reflect any change in value since the previous time the
positions were marked to market. This process prevents uncollateralized
exposures from accumulating over time, which prevents the accumulation
of additional counterparty credit risk on a position, and thereby
reduces the size of exposure at default should one occur.
---------------------------------------------------------------------------
\56\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21765 (citing the Affiliated Entities Proposal, 77
FR at 50429).
---------------------------------------------------------------------------
Accordingly, the Commission proposes to reinstate and revise the
provision permitting all non-U.S. counterparties to pay and collect
full variation margin daily on all of the eligible affiliate
counterparties' swaps with other eligible affiliate counterparties.
Request for Comment. The Commission requests comment on the
provisions for the collection of variation margin on swaps with
affiliated counterparties. The proposed alternative compliance
frameworks may produce a permanent residual class of swaps that are not
cleared but instead result in the exchange of variation margin between
eligible affiliate counterparties. Are there any additional risks to
the counterparties or the market that have not been considered in this
proposal, or any systemic risk implications for the United States, from
the existence of such a class of swaps? If so, please describe such
risks.
Are there other alternatives to the provisions for the collection
of variation margin that the Commission should consider?
2. Variation Margin for Swaps With Affiliated Counterparties Under
Commission Regulation 50.52(b)(4)(ii)
Commission regulation 50.52(b)(4)(ii), as reinstated and revised,
would permit each eligible affiliate counterparty, or a third party
that directly or indirectly holds a majority interest in both eligible
affiliate counterparties, to pay and collect full variation margin
daily on all of the eligible affiliate counterparties' swaps with other
eligible affiliate counterparties, if at least one of the eligible
affiliate counterparties is located in Australia, Canada, the European
Union, Hong Kong, Japan, Mexico, Singapore, Switzerland, or the United
Kingdom.\57\ This approach is similar to current Commission regulation
50.52(b)(4)(ii)(A)(2), but with an expanded list of jurisdictions.
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\57\ The Commission is proposing to expand the list of
jurisdictions under Commission regulation 50.52(b)(4)(ii) to include
the United Kingdom as a separate jurisdiction from the European
Union, in order to codify the no-action relief issued in preparation
for the United Kingdom's withdrawal from the European Union,
commonly referred to as ``Brexit.'' CFTC Letter No. 19-09 (April 5,
2019), available at https://www.cftc.gov/csl/19-09/download.
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However, the Commission is not proposing to reinstate the provision
to permit eligible affiliate counterparties to pay and collect
variation margin on all swaps entered into between the eligible
affiliate counterparty located outside of the U.S. and an unaffiliated
counterparty (current Commission regulation 50.52(b)(4)(ii)(A)(1)). The
Commission understands that eligible affiliate counterparties electing
to comply with the Alternative Compliance Framework as permitted by
[[Page 70452]]
a staff no-action letter currently choose to pay and collect variation
margin on swaps with affiliated counterparties rather than with
unaffiliated counterparties. Therefore, in order to offer a simplified
and streamlined Alterative Compliance Framework, the Commission
proposes to reinstate only the provision upon which the Commission
preliminarily believes eligible affiliate counterparties have been
relying as a matter of market practice.
Request for Comment. The Commission requests comment as to whether
any eligible affiliate counterparty has paid and collected variation
margin on swaps with unaffiliated counterparties only under the relief
equivalent to current Commission regulation 50.52(b)(4)(ii)(A)(1). If
an eligible affiliate counterparty has complied with this provision,
then the Commission requests comment as to why that provision was
preferable to paying and collecting variation margin on all swaps with
other eligible affiliate counterparties under the relief equivalent to
current Commission regulation 50.52(b)(4)(ii)(A)(2). To what extent is
compliance with the Outward-Facing Swaps Condition via the Alternative
Compliance Frameworks consistent or inconsistent with margin
requirements in non-U.S. jurisdictions?
3. Permanent Availability of the Alternative Compliance Framework Under
Commission Regulation 50.52(b)(4)(ii)
Unlike Commission regulation 50.52(b)(4)(ii)(A), which expired on
March 11, 2014, proposed revised regulation 50.52(b)(4)(ii) would be
reinstated without an expiration date. The proposed regulation also
would be expanded to include non-U.S. eligible affiliate counterparties
located in Australia, Canada, Hong Kong, Mexico, Switzerland, or the
United Kingdom, as well as eligible affiliate counterparties located in
the European Union, Japan, or Singapore.
Market participants began relying on the Alternative Compliance
Frameworks under Commission regulation 50.52(b)(4)(ii)(A) in 2013. The
Commission is unaware of any compliance problems during the year-long
period the regulation was in effect or under the DCR no-action letters
that have provided relief equivalent to the expired Alternative
Compliance Frameworks. This includes the period of time during which
counterparties from the expanded list of countries have been eligible
to use an Alternative Compliance Framework. Accordingly, the Commission
preliminarily believes that codifying the current practice sufficiently
addresses the risk transfer concerns that the Outward-Facing Swaps
Condition was intended to resolve and would be responsive to the clear
request from market participants for the staff no-action letters to be
codified.\58\
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\58\ As noted above, the Commission received four comment
letters in 2017 requesting that the Commission extend the
availability of, or codify, CFTC Letter No. 16-81.
---------------------------------------------------------------------------
Request for Comment. The Commission requests comment regarding the
proposal to make the Alternative Compliance Frameworks a permanent
option for non-U.S. eligible affiliate counterparties to comply with
the Outward-Facing Swaps Condition of the Inter-Affiliate Exemption.
Does codifying the current practice sufficiently address the risk
transfer concerns that the Outward-Facing Swaps Condition was intended
to resolve?
4. Proposing Not To Reinstate Commission Regulation 50.52(b)(4)(ii)(B)
The proposed reinstated and revised Alternative Compliance
Frameworks would not include a provision similar to Commission
regulation 50.52(b)(4)(ii)(B). Expired Commission regulation
50.52(b)(4)(ii)(B) permitted an eligible affiliate counterparty located
in the European Union, Japan, or Singapore to elect the Inter-Affiliate
Exemption without clearing an outward-facing swap or complying with the
variation margin requirements currently set forth in subparagraph
(b)(4)(ii)(A), provided that the majority owner of the affiliate
counterparties, is not a ``financial entity'' under section
2(h)(7)(C)(i) of the CEA and neither eligible affiliate counterparty is
affiliated with an entity that is a swap dealer or major swap
participant, as defined in Commission regulation 1.3.
Based on a review of swap data, the Commission preliminarily
believes that the Inter-Affiliate Exemption has been elected only by
financial entities or entities affiliated with a swap dealer. The
absence of other entity types electing the Inter-Affiliate Exemption
may be due to the existence of the exception to the clearing
requirement for non-financial end-users (End-User Exception under
Commission regulation 50.50) and the exemption from the clearing
requirement for certain cooperative entities (Cooperative Exemption
under Commission regulation 50.51). Thus, in order to codify simplified
Alternative Compliance Frameworks, the Commission proposes not to
reinstate the provision under Commission regulation 50.52(b)(4)(ii)(B).
Request for Comment. The Commission requests comment as to whether
an entity has relied on, or intends to rely on, the relief equivalent
to the expired Alternative Compliance Framework in Commission
regulation 50.52(b)(4)(ii)(B).
5. Proposing To Reinstate and Revise Commission Regulation
50.52(b)(4)(iii)
While proposed revised regulation 50.52(b)(4)(ii) would be
available to six additional jurisdictions, the Commission recognizes
that eligible affiliate counterparties may be located in other non-U.S.
jurisdictions and proposes to reinstate a modified Alternative
Compliance Framework under Commission regulation 50.52(b)(4)(iii) to
address swaps entered into by eligible affiliate counterparties in the
remaining jurisdictions that have not been identified under proposed
revised regulation 50.52(b)(4)(ii).
As described above, expired Commission regulation 50.52(b)(4)(iii)
permitted an eligible affiliate counterparty located in a non-U.S.
jurisdiction (other than the European Union, Japan, or Singapore) to
comply with variation margin requirements analogous to those available
in Commission regulation 50.52(b)(4)(ii) for uncleared swaps subject to
Commission regulation 50.4, provided that the U.S. counterparty's swaps
with affiliates in all jurisdictions other than the European Union,
Japan, and Singapore did not exceed five percent of the aggregate
notional value of all of the U.S. counterparty's swaps subject to
Commission regulation 50.4. The provisions of Commission regulation
50.52(b)(4)(iii) (including the ``five percent test'') are intended to
apply to the ``other jurisdictions.'' Because the Commission is
proposing to expand the jurisdictions eligible for the Alternative
Compliance Framework under Commission regulation 50.52(b)(4)(ii), it is
proposing to amend the jurisdictions identified as ``other
jurisdictions'' in a corresponding manner.
The five percent test establishes a relative limit on the amount of
uncleared swaps activity--activity that would otherwise be subject to
the Commission's clearing requirement--that any one U.S. eligible
affiliate counterparty may conduct with its affiliated counterparties
in certain ``other jurisdictions.'' In other words, the U.S. affiliate
cannot enter into swaps that total (in aggregate) more than five
percent of all of its swaps that are
[[Page 70453]]
subject to the Commission's clearing requirement, with affiliates in
the ``other jurisdictions.'' The five percent test has the practical
effect of limiting the relative notional amount of uncleared swaps
activity that affiliates conduct in jurisdictions that are not
identified in Commission regulation 50.52(b)(4)(ii). The Commission
continues to believe that limiting the relative notional amount of
uncleared swaps executed in jurisdictions that have not established or
implemented clearing regimes, along with conditioning relief on the use
of variation margin, protects the eligible affiliate counterparty
located in the United States from exposure to the risks associated with
material swaps exposure in jurisdictions that do not have their own
domestic clearing regime. There also exists the possibility that
parties may alter their swaps trading in response to the proposed
expansion of the number of jurisdictions excluded from the five percent
limitation. To the extent that it now applies to fewer countries, a
market participant's five percent exposure may be comprised of swaps
with counterparties in less sophisticated swaps markets. The Commission
invites comment on the market incentives and likely outcomes of its
proposal.
The five percent test was adopted by the Commission as a time-
limited measure to facilitate compliance with the Outward-Facing Swaps
Condition. Before the provisions of the Alternative Compliance
Frameworks expired in March 2014, DCR issued no-action letters designed
to lengthen the transition period and to permit entities to continue
complying with the terms in Commission regulation 50.52(b)(4)(iii). The
Commission recognized that there may be affiliated counterparties
located outside of the United States, the European Union, Japan, or
Singapore, that would be engaging in inter-affiliate swaps and would
need an alternative compliance mechanism until the unlisted
jurisdictions implemented a clearing regime.
Now, six years after the Commission implemented its first clearing
requirement, affiliated entities still face difficulties clearing
outward-facing swaps locally, particularly in jurisdictions that have
not adopted domestic clearing regimes. For this reason, the Commission
is proposing to reinstate the Alternative Compliance Framework included
under Commission regulation 50.52(b)(4)(iii), and to redefine the
jurisdictions that will be eligible. The Commission is proposing to
amend regulation 50.52(b)(4)(iii) to identify jurisdictions other than
Australia, Canada, the European Union, Hong Kong, Japan, Mexico,
Singapore, Switzerland, the United Kingdom, or the United States as the
``other jurisdictions.'' The Commission preliminarily believes that the
jurisdictions included in revised regulation 50.52(b)(4)(ii) have all
established domestic clearing regimes and requirements that will help
to protect against evasion of the Commission's clearing requirement.
The list of jurisdictions excluded from ``other'' is the same as the
list of jurisdictions eligible for the Alternative Compliance Framework
under 50.52(b)(4)(ii), and then it also adds the United States.
Request for Comment. The Commission requests comment as to whether
an entity has relied on, or intends to rely on, the relief equivalent
to the expired Alternative Compliance Framework provided in Commission
regulation 50.52(b)(4)(iii)(B). Additionally, the Commission requests
comment as to whether the five percent test outlined in Commission
regulation 50.52(b)(4)(iii) should be reinstated and updated as
proposed, or whether the Commission should delete the expired provision
and eliminate the five percent test.
6. Proposing Not To Reinstate Commission Regulation 50.52(b)(4)(iii)(A)
As the Commission has noted above, it is not aware of any eligible
affiliate counterparties that have chosen to comply with the relief
equivalent to the expired Alternative Compliance Frameworks using the
option to pay and collect variation margin on swaps with all
unaffiliated counterparties. The Commission understands that, just as
eligible affiliate counterparties elect to comply with the Alternative
Compliance Framework under the terms of Commission regulation
50.52(b)(4)(ii)(A)(2), any eligible affiliate counterparties complying
with Commission regulation 50.52(b)(4)(iii) choose to pay and collect
variation margin on swaps with all other eligible affiliate
counterparties as contemplated by Commission regulation
50.52(b)(4)(iii)(B). Thus, in order to reinstate a simplified
Alternative Compliance Framework and because the Commission
preliminarily believes that the relief equivalent to Commission
regulation 50.52(b)(4)(iii)(A) has not been relied upon by market
participants, the Commission proposes not to reinstate the provision
under Commission regulation 50.52(b)(4)(iii)(A).
Request for Comment. The Commission requests comment as to whether
a market participant has relied on, or intends to rely on, the relief
equivalent to the expired Alternative Compliance Framework provided in
Commission regulation 50.52(b)(4)(iii)(A).
7. Additional Revisions to Commission Regulation 50.52
As part of its proposal to reinstate the Alternative Compliance
Framework provisions of Commission regulation 50.52(b)(4)(iii), and to
make them available to eligible affiliate counterparties located in
certain non-U.S. jurisdictions, the Commission is proposing to add a
definition of ``United States'' to revised regulation 50.52(a)(2)
identical to the one in Commission regulation 23.160(a) (cross-border
application of the uncleared margin regulations). This provision
defines the United States to mean ``the United States of America, its
territories and possessions, any State of the United States, and the
District of Columbia.'' The new definition of United States is
referenced in proposed revised regulation 50.52(b)(4)(iii).
The Commission preliminarily believes that the proposed revisions
to regulation 50.52(b)(4) provide an exemption from the Commission's
clearing requirement, in a manner that is demonstrated to be workable,
while imposing conditions necessary to ensure that inter-affiliate
swaps exempted from required clearing meet certain risk-mitigating
conditions. In addition, the Commission preliminarily believes that the
proposed revisions would provide more flexibility to eligible affiliate
counterparties electing the Inter-Affiliate Exemption and would
increase legal certainty for the reasons stated above.
Request for Comment. The Commission requests comment on the
proposal to include a definition for the term ``United States'' as it
is used in the revised and reinstated regulation 50.52. More broadly,
the Commission requests comment as to whether the proposed modified
Outward-Facing Swaps Condition and reinstated Alternative Compliance
Frameworks will prevent market participants from using the Inter-
Affiliate Exemption to evade the Commission's clearing requirement or
transfer risk to U.S. firms by entering into uncleared swaps with non-
U.S. affiliates.
B. Commission's Section 4(c) Authority
The Commission issued the Inter-Affiliate Exemption pursuant to
section 4(c)(1) of the CEA, which grants the Commission the authority
to exempt any transaction or class of transactions,
[[Page 70454]]
including swaps, from certain provisions of the CEA, including the
Commission's clearing requirement, in order to ``promote responsible
economic or financial innovation and fair competition.'' Section
4(c)(2) of the CEA further provides that the Commission may not grant
exemptive relief unless it determines that: (1) The exemption is
appropriate for the transaction and consistent with the public
interest; (2) the exemption is consistent with the purposes of the CEA;
(3) the transaction will be entered into solely between ``appropriate
persons''; and (4) the exemption will not have a material adverse
effect on the ability of the Commission or any contract market to
discharge its regulatory or self-regulatory responsibilities under the
CEA. In enacting section 4(c), Congress noted that the purpose of the
provision is to give the Commission a means of providing certainty and
stability to existing and emerging markets so that financial innovation
and market development can proceed in an effective and competitive
manner.\59\
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\59\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179,
3213.
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The Commission preliminarily believes that the exemption, as
modified in this proposal, is consistent with the public interest and
with the purposes of the CEA. As the Commission noted in the adopting
release to the Inter-Affiliate Exemption, inter-affiliate swaps provide
an important risk management role within corporate groups.\60\ These
swaps may be beneficial to the entity as a whole. The proposed
revisions to the Outward-Facing Swaps Condition and the Alternative
Compliance Frameworks would facilitate use of the Inter-Affiliate
Exemption by permitting the variation margin provisions under proposed
Commission regulation 50.52(b)(4)(ii) and (iii) to be used in
connection with swaps with eligible affiliate counterparties located in
any non-U.S. jurisdiction, not only those located in the European
Union, Japan, or Singapore. Pursuant to no-action relief issued by DCR,
as discussed above, these provisions have been in use since 2013.
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\60\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21754 (citing to commenters and the proposal in
support of the conclusion that ``inter-affiliate transactions
provide an important risk management role within corporate groups''
and that ``swaps entered into between corporate affiliates, if
properly risk-managed, may be beneficial to the entity as a
whole.'').
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Based on the Commission's review of data reported to the Depository
Trust & Clearing Corporation's (DTCC's) swap data repository, DTCC Data
Repository (U.S.) LLC (DDR), the Alternative Compliance Framework
provisions under Commission regulation 50.52(b)(4)(ii) appear to be
working because the Commission has identified approximately 50 entities
located in Australia, Canada, the European Union, Hong Kong, Japan,
Mexico, Singapore, Switzerland, or the United Kingdom that elected the
Inter-Affiliate Exemption between January 1, 2018 to December 31,
2018.\61\ The Commission preliminarily believes that these entities
chose to, or could have, complied with the Alternative Compliance
Framework under Commission regulation 50.52(b)(4)(ii) because of the
jurisdiction in which they are organized. Based on the same data set
from January 1, 2018 to December 31, 2018, the Commission identified 12
entities located in jurisdictions other than Australia, Canada, the
European Union, Hong Kong, Japan, Mexico, Singapore, Switzerland, the
United Kingdom, or the United States that elected the Inter-Affiliate
Exemption and chose to, or could have, complied with the Alternative
Compliance Framework under Commission regulation 50.52(b)(4)(iii).
During the same time period, the data showed that approximately 70 U.S.
entities elected the Inter-Affiliate Exemption.
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\61\ The Commission notes that although current Commission
regulation 50.52 does not permit entities to comply with either of
the Alternative Compliance Frameworks because they have expired, the
relief provided by DCR no-action letters means that market
participants have continued to use and report swaps activity in
compliance with the Alternative Compliance Frameworks.
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The Commission preliminarily believes that reinstating the
Alternative Compliance Frameworks as permanent provisions, and
extending the availability of the first framework under Commission
regulation 50.52(b)(4)(ii) to eligible affiliate counterparties located
in Australia, Canada, the European Union, Hong Kong, Japan, Mexico,
Singapore, Switzerland, and the United Kingdom while correspondingly
narrowing the availability of the second framework under Commission
regulation 50.52(b)(4)(iii), would be appropriate for inter-affiliate
swap transactions, would promote responsible financial innovation and
fair competition, and would be consistent with the public interest.
In this regard, the Commission considered whether the availability
of the proposed Alternative Compliance Frameworks might result in fewer
affiliated counterparties clearing their outward-facing swaps and the
significance of any such reduction in terms of the use of inter-
affiliate swaps as a risk management tool. Generally speaking, it is
difficult to estimate whether the proposed rule will reduce central
clearing of outward-facing swaps. Among other factors, the application
of mandatory clearing and the availability of central clearing for
particular types of swaps vary by jurisdiction. Also, market
participants' response to the proposed rule may depend on which of
their swaps are eligible for the Inter-Affiliate Exemption. Despite
this uncertainty, the Commission believes that there may be a
significant number of affiliated counterparties that will continue to
engage in uncleared swaps activity as permitted under the proposed
Alternative Compliance Frameworks.\62\
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\62\ Based on a review of DDR data reflecting past use of the
Inter-affiliate Exemption, the Commission estimates that up to 70
eligible affiliate counterparties located outside of the United
States may elect to comply with one of the reinstated Alternative
Compliance Frameworks thereby choosing not to clear their outward-
facing swaps and rather to pay and collect variation margin on all
swaps with other eligible affiliated counterparties instead. These
70 entities include affiliates of swap dealers that are active in
multiple jurisdictions.
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As noted above, swap dealers electing the exemption use inter-
affiliate swaps as an important risk management tool within corporate
groups and these affiliated groups are subject to a range of regulatory
and other controls as part of their swap activities in the United
States and in other jurisdictions. In sum, in considering whether the
proposed exemption would promote responsible financial innovation and
fair competition and would be consistent with the public interest, the
Commission took the factors discussed above into account--i.e., the
value of inter-affiliate swaps as a risk management tool, the extent to
which the Alternative Compliance Frameworks would foster this use of
inter-affiliate swaps, and the potential for more elections not to
clear outward-facing swaps.
The Commission believes that the proposed revisions to the Outward-
Facing Swaps Condition and Alternative Compliance Frameworks would be
available only to ``appropriate persons.'' Section 4(c)(3) of the CEA
includes within the term ``appropriate person'' a number of specified
categories of persons, including such other persons that the Commission
determines to be appropriate in light of their financial or other
qualifications, or the applicability of appropriate regulatory
protections. In the 2013 Inter-Affiliate Exemption final rulemaking,
the Commission found that eligible contract participants (ECPs) are
appropriate persons within the scope of
[[Page 70455]]
section 4(c)(3)(K) of the CEA.\63\ The Commission noted that the
elements of the ECP definition (as set forth in section 1a(18)(A) of
the CEA and Commission regulation 1.3(m)) generally are more
restrictive than the comparable elements of the enumerated
``appropriate person'' definition. Given that only ECPs are permitted
to enter into uncleared swaps, there is no risk that a non-ECP or a
person who does not satisfy the requirements for an ``appropriate
person'' could enter into an uncleared swap using the Inter-Affiliate
Exemption. Therefore, for purposes of this proposal, the Commission
reaffirms its finding that the class of persons eligible to rely on the
Inter-Affiliate Exemption will be limited to ``appropriate persons''
within the scope of section 4(c)(3) of the CEA.
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\63\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21754.
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Finally, the Commission preliminarily finds that the proposed
revised Inter-Affiliate Exemption will not have a material effect on
the ability of the Commission to discharge its regulatory
responsibilities. This exemption continues to be limited in scope and,
as described further below, the Commission will continue to have access
to information regarding the inter-affiliate swaps subject to this
exemption because they will be reported to an SDR pursuant to the
conditions of the exemption. In addition to the reporting conditions in
the rule, the Commission retains its special call, anti-fraud, and
anti-evasion authorities, which will enable it to adequately discharge
its regulatory responsibilities under the CEA.
For the reasons described in this proposal, the Commission
preliminarily believes it would be appropriate and consistent with the
public interest to amend the Outward-Facing Swaps Condition and
Alternative Compliance Frameworks as proposed.
Request for Comment. The Commission requests comment as to whether
the proposed revisions to the Outward-Facing Swaps Condition and
Alternative Compliance Frameworks would be an appropriate exercise of
the Commission's authority under section 4(c) of the CEA. The
Commission also requests comment as to whether the proposed revisions
to the Outward-Facing Swaps Condition and Alternative Compliance
Frameworks would be in the public interest.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires agencies to consider
whether the rules they propose will have a significant economic impact
on a substantial number of small entities and, if so, provide a
regulatory flexibility analysis respecting the impact.\64\ The proposed
revisions to the Inter-Affiliate Exemption contained in this proposed
rulemaking will not affect any small entities, as the RFA uses that
term. Pursuant to section 2(e) of the CEA, only ECPs may enter into
swaps, unless the swap is listed on a DCM. The Commission has
previously determined that ECPs are not small entities for purposes of
the RFA.\65\ The proposed revisions to the Inter-Affiliate Exemption
would only affect ECPs because all persons that are not ECPs are
required to execute their swaps on a DCM, and all contracts executed on
a DCM must be cleared by a DCO, as required by statute and regulation,
not by operation of any clearing requirement determination. Therefore,
the Chairman, on behalf of the Commission, hereby certifies pursuant to
5 U.S.C. 605(b) that this proposed rulemaking will not have a
significant economic impact on a substantial number of small entities.
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\64\ 5 U.S.C. 601 et seq.
\65\ 66 FR 20740, 20743 (Apr. 25, 2001).
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B. Paperwork Reduction Act
The Paperwork Reduction Act (PRA) \66\ imposes certain requirements
on federal agencies, including the Commission, in connection with
conducting or sponsoring any collection of information as defined by
the PRA. This proposed rulemaking will not require a new collection of
information from any persons or entities. The Commission is not
proposing to amend the reporting requirements of Commission regulations
50.52(c) and (d), for which the Office of Management and Budget has
assigned control number 3038-0104.
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\66\ 44 U.S.C. 3507(d).
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C. Cost-Benefit Considerations
1. Statutory and Regulatory Background
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity; (3) price discovery; (4) sound
risk management practices; and (5) other public interest considerations
(collectively referred to herein as the Section 15(a) Factors.)
Accordingly, the Commission considers the costs and benefits associated
with the proposed amendments to the Inter-Affiliate Exemption in light
of the Section 15(a) Factors.
In the sections that follow, the Commission considers: (1) The
costs and benefits of reinstating modified Alternative Compliance
Frameworks to the Inter-Affiliate Exemption as described in this
proposed rule; (2) the alternatives contemplated by the Commission and
their costs and benefits; and (3) the impact on the Section 15(a)
Factors of reinstating the availability of modified Alternative
Compliance Frameworks to the Inter-Affiliate Exemption.
The regulatory baseline for this rulemaking is the current swap
clearing requirement and the inter-affiliate exemption codified in
Commission regulation 50.52. The Alternative Compliance Frameworks
included in Commission regulations 50.52(b)(4)(ii) and (iii) expired as
of March 11, 2014. As a practical matter, market participants have
continued to use the Alternative Compliance Frameworks because DCR
issued a series of no-action letters stating that it would not
recommend that the Commission commence an enforcement action against
entities using the Alternative Compliance Frameworks. As such, to the
extent that market participants have relied upon relevant Commission
staff action, the actual costs and benefits of this proposal, as
realized in the market, may not be as significant.
However, because the current Alternative Compliance Frameworks have
expired, the Commission's regulatory baseline for the costs and
benefits consideration is the requirement that all market participants
must comply with the Outward-Facing Swaps Condition pursuant to
Commission regulation 50.52(b)(4)(i), by either clearing the swap or
complying with an exception to or exemption from the clearing
requirement. The Commission will assess the costs and benefits of
reinstating modified Alternative Compliance Frameworks as if they are
not available currently.
Although the Alternative Compliance Frameworks were unavailable
according to the text of Commission regulation 50.52, during the 2018
calendar year the Commission was able to monitor the number of entities
complying with the Outward-Facing Swaps Condition through the
Alterative Compliance Frameworks, as permitted by DCR no-action
letters.
The Commission notes that the consideration of costs and benefits
[[Page 70456]]
below is based on the understanding that the markets function
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with some Commission registrants
being organized outside of the United States; with leading industry
members typically conducting operations both within and outside the
United States; and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
below discussion of costs and benefits refers to the effects of the
proposed rule on all activity subject to the proposed and amended
regulations, whether by virtue of the activity's physical location in
the United States or by virtue of the activity's connection with or
effect on U.S. commerce under section 2(i) of the CEA.\67\ In
particular, the Commission notes that a significant number of entities
affected by this proposed rulemaking are located outside of the United
States.
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\67\ 7 U.S.C. 2(i).
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2. Considerations of the Costs and Benefits of the Commission's Action
a. Costs
By reinstating modified Alternative Compliance Frameworks to the
Outward-Facing Swaps Condition in the Inter-Affiliate Exemption, the
proposed rule would permit affiliated entities to elect not to clear
swaps with unaffiliated entities that would otherwise be subject to the
Commission's clearing requirement. Under current Commission regulation
50.52, all eligible affiliate counterparties must either clear swaps
subject to the clearing requirement or qualify for an exception to or
exemption from the clearing requirement. This proposal would allow
eligible affiliate counterparties to be exposed to greater measures of
counterparty credit risk under the Alternative Compliance Frameworks
than if they cleared these swaps. Clearing, along with the Commission's
requirements related to swap clearing, mitigates counterparty credit
risk in the following ways: (1) An FCM guarantees the performance of a
customer and in so doing, takes steps to monitor and mitigate the risk
of a counterparty default; (2) a clearinghouse collects sufficient
initial margin to cover potential future exposures and regularly
collects and pays variation margin to cover current exposures; (3) a
clearinghouse has rules, and enforcement mechanisms to ensure the rules
are followed, to mark a swap to market and to require that margin be
posted in a timely fashion; (4) a clearinghouse facilitates netting
within portfolios of swaps and among counterparties; and (5) a
clearinghouse holds collateral in a guaranty fund in order to mutualize
the remaining tail risk not covered by initial margin contributions
among clearing members.\68\ These risk mitigating factors may be
attenuated as parties elect to use the Alternative Compliance
Frameworks.
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\68\ See Clearing Requirement Determination Under Section 2(h)
of the CEA for Interest Rate Swaps, 81 FR 71230.
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Furthermore, there may be an increased risk of contagion and
systemic risk to the financial system that results from permitting
additional market participants to use the Alternative Clearing
Frameworks to avoid clearing certain swaps subject to the clearing
requirement. Swap clearing mitigates risk on a transaction level, as
outlined above, and it also provides protection against risk transfer
throughout the financial system. As discussed further below, this cost
is minimized to the extent that variation margin is an effective risk
management tool for swap market participants to prevent the
accumulation of uncollateralized risk.
As proposed, reinstating the modified Alternative Compliance
Frameworks would permit eligible affiliates that would otherwise be
required to clear an outward-facing swap, to instead pay and collect
full variation margin daily on all swaps between eligible affiliate
counterparties, provided that all other conditions of the Alternative
Compliance Frameworks are satisfied. This may result in decreased
clearing activity and decreased liquidity in non-U.S. markets and at
clearinghouses where eligible affiliate counterparties previously might
have cleared such outward-facing swaps, but will now be able to
maintain such risk internally through a series of inter-affiliate swaps
and variation margining.
Finally, the availability of the modified Alternative Compliance
Frameworks may increase the costs to any third party creditor to an
entity using an Alternative Compliance Framework instead of clearing
its outward-facing swaps. While the variation margin requirement
included in this proposal mitigates the buildup of credit risk within a
corporate group that uses a centralized risk management structure, it
is still possible that using variation margin instead of clearing
outward-facing swaps could produce additional counterparty risk to
external creditors and/or third parties. In addition, as discussed
above, expanding the number of jurisdictions excluded from the five
percent limitation may cause market participants to alter their swaps
trading behavior. To the extent that it now applies to fewer countries,
a market participant's five percent exposure may be comprised of swaps
with counterparties located in less sophisticated swaps markets. Such
swaps may pose higher risks and overall costs could increase.
Request for Comment. The Commission requests comment, including any
available quantitative data and analysis, on the expected costs
resulting from the proposed revisions to the Outward-Facing Swaps
Condition and Alternative Compliance Frameworks in the Inter-Affiliate
Exemption.
b. Benefits
Because the Commission's current regulation does not permit
eligible affiliate counterparties to use the Alternative Compliance
Frameworks, this proposal is expected to provide a benefit to eligible
affiliate counterparties seeking additional flexibility in their inter-
affiliate swap risk management. To the extent that complying with the
variation margin provisions of the modified Alternative Compliance
Frameworks is less expensive than clearing an outward-facing swap,
market participants would be able to avail themselves of these cost
savings. For example, entities that choose to comply with the
Alternative Compliance Frameworks as proposed would not need to pay the
costs of posting incremental initial margin to either FCMs or
clearinghouses, or paying any additional clearing fees. All of these
savings would provide a benefit to eligible affiliate counterparties
that choose to comply with the Alternative Compliance Frameworks rather
than to clear a swap.
Entities within a corporate group may benefit from better risk
transfers between affiliates. Current Commission regulation 50.52
provides little flexibility to market participants and requires them to
either clear the outward-facing swap or comply with an exception to or
exemption from the clearing requirement. Certain corporate entities
might be incentivized by the new availability of the Alternative
Compliance Frameworks to increase their inter-affiliate swap activity
in order to increase the benefits of centralized risk management
because they can use the Alternative Compliance Frameworks rather than
clearing outward-facing swaps.
[[Page 70457]]
There are additional benefits this proposal may provide to
affiliates by improving and increasing options for the transfer of risk
between affiliated entities. Entities most often elect to transact and
clear inter-affiliate swaps in the most liquid market (reducing costs).
The Commission notes that affiliated entities may choose in which
jurisdiction to clear outward-facing swaps under current Commission
regulation 50.52. The modified Alternative Compliance Frameworks may
increase the number of options that affiliate entities have to comply
with the Outward-Facing Swaps Condition, and thus, may increase the
number of entities electing the Inter-Affiliate Exemption or even
increase the number of inter-affiliate swaps that are entered into to
transfer risk between entities. This represents an additional benefit
to entities that would be induced to elect the Inter-Affiliate
Exemption because of changes to the Alternative Compliance Frameworks
that otherwise would not have engaged in any (or would have engaged in
less) centralized risk management or risk transfers.
As stated above, the Commission estimates that approximately 50
entities in Australia, Canada, the European Union, Hong Kong, Japan,
Mexico, Singapore, Switzerland, or the United Kingdom have used or
potentially would use the modified Alternative Compliance Framework
under Commission regulation 50.52(b)(4)(ii), if adopted pursuant to
this proposal. Furthermore, the Commission estimates that as many as 12
entities might elect to use the modified Alternative Compliance
Framework under Commission regulation 50.52(b)(4)(iii).\69\ Besides the
difficulty in determining who might use the Alternative Compliance
Framework, the estimation of the benefit to each entity is further
complicated by the differing costs and capital structures related to
each entity. Further, the Commission realizes that there may be more
entities in the future that would elect to pay and collect variation
margin rather than clear outward-facing swaps if they are electing the
Inter-Affiliate Exemption.
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\69\ The Commission would expect use of the Alternative
Compliance Framework available under proposed revised regulation
50.52(b)(4)(iii) to increase in additional jurisdictions over time
as swaps markets develop. The current estimate of up to 12 entities
complying with the Alternative Compliance Framework under proposed
revised regulation 50.52(b)(4)(iii) in unlisted jurisdictions may be
a low estimate.
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Request for Comment. The Commission requests comment on which
entities might elect to use the Alternative Compliance Framework. The
Commission also requests comment on the benefits that would likely
result from the proposed revisions to the Outward-Facing Swaps
Condition and Alternative Compliance Frameworks in the Inter-Affiliate
Exemption, and, if any, the expected magnitude of such benefits.
3. Costs and Benefits of the Proposed Rule as Compared to Alternatives
The Commission considered two alternatives to this proposal to
adopt modified Alternative Compliance Frameworks.\70\ First, the
Commission considered adopting new Alternative Compliance Frameworks
that include expiration dates, after which point in time non-U.S.
eligible affiliate counterparties would be required to clear any
outward-facing swaps, or otherwise satisfy the Outward-Facing Swaps
Condition. When the Commission adopted the Inter-Affiliate Exemption in
2013 it included an expiration date, March 11, 2014, for the
alternative compliance framework because the Commission believed that a
one year transition period after the adoption of the Commission's
clearing requirement in March 2013 was appropriate. The Commission
preliminarily believes that time-limited Alternative Compliance
Frameworks would provide little additional benefit to market
participants while potentially distorting long-range planning. In
general, a regulatory time limit can be useful in focusing attention,
but it can also cause distortions as market participants make plans
based on an arbitrary date rather than their business needs. The
Commission preliminarily believes that adopting modified Alternative
Compliance Frameworks without expiration dates would increase planning
flexibility for swap market participants, which could be especially
beneficial as additional jurisdictions adopt, implement, and change
their mandatory clearing regimes in ways that the Commission cannot
predict at this time. In view of this uncertainty and the uncertainty
regarding clearing requirement comparability determinations described
above, the Commission preliminarily does not see the value in setting a
new expiration date for the regulation. The Commission notes that it
generally retains the authority to modify its regulations as changing
conditions warrant.
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\70\ The Commission acknowledges that the legal framework for
establishing a substituted compliance regime could have been an
additional component of this proposal. This proposal would have
taken into account existing regulation 50.52(b)(4)(i)(B), which
provides for compliance with a foreign jurisdiction's clearing
mandate that is comparable, and comprehensive, but not necessarily
identical to the Commission clearing requirement as a means of
satisfying the conditions of the regulation. However, the Commission
believes that it is impractical at this time to set up a substituted
compliance regime for required clearing that would serve as a
meaningful alternative given that the swaps and types of market
participants covered by foreign mandatory clearing regimes vary
significantly from Part 50 of the Commission's regulations.
Accordingly, the Commission is not proposing or considering this
alternative at this time.
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Second, the Commission considered the alternative of not amending
the current Alternative Compliance Frameworks regulations that have
expired. Without modified Alternative Compliance Frameworks that permit
eligible affiliate counterparties to pay and collect variation margin
on certain inter-affiliate swaps, market participants would have to
determine whether any alternatives to clearing outward-facing swaps are
available. The availability of these alternatives to clearing, if any,
would vary in across jurisdictions and may depend on the terms of the
transaction in question. Therefore, the Commission cannot predict
whether eliminating the Alternative Compliance Frameworks is a viable
option. In addition, the potential lack of alternatives to clearing
could lead eligible affiliate counterparties to reduce their use of
inter-affiliate swaps for risk management purposes, which would not be
a positive result because inter-affiliate swaps are an important
component of centralized risk management. Finally, eliminating the
Alternative Compliance Frameworks could cause market distortions if it
leads market participants to conduct their swap-related activities
based on the availability of regulatory exemptions rather than their
business needs.
Request for Comment. The Commission requests comment on the costs
and benefits of reinstating modified Alternative Compliance Frameworks
compared to the costs and benefits of (i) adopting modified Alternative
Compliance Frameworks that include expiration dates, and (ii) making no
amendments to the current Outward-Facing Swaps Condition to the Inter-
Affiliate Exemption. The Commission requests quantitative data and
analysis where possible.
4. Section 15(a) Factors
a. Protection of Market Participants and the Public
In revising the Outward-Facing Swaps Condition and Alternative
Compliance Frameworks, the Commission considered various ways to
appropriately protect affiliated entities, third parties in the swaps
market, and the public. The Commission seeks to
[[Page 70458]]
ensure that the proposal prevents swap market participants from evading
the Commission's clearing requirement and/or transferring excessive
risk to an affiliated U.S. entity through the use of uncleared inter-
affiliate swaps. The Commission proposes to permit eligible affiliate
counterparties to elect not to clear an outward-facing swap subject to
the clearing requirement, but only if eligible affiliates pay and
collect daily variation margin on swaps.
The Commission also considered the potential effects on the public
of providing this alternative to clearing outward-facing swaps subject
to the clearing requirement. In particular, the Commission considered
the extent to which the proposed Alternative Compliance Frameworks
might result in fewer affiliated counterparties clearing their outward-
facing swaps. One difficulty in estimating the effect of the proposal
is the fact that the application of mandatory clearing and the
availability of central clearing for particular types of swaps vary by
jurisdiction. Also, many market participants enter into swaps and other
financial instruments in multiple jurisdictions, which may give them
the ability to adjust their financial and risk management activity in
response to regulatory requirements.
In the face of this uncertainty, the Commission believes that, even
if the change in clearing activity and business for clearinghouses is
uncertain, there may be a significant number of affiliated
counterparties that will continue to engage in swaps activity permitted
under the proposed Alternative Compliance Frameworks.\71\ The
Commission understands that the swap dealers conduct their swaps
activities using affiliates in various jurisdictions. Swap dealers
engage in inter-affiliate swaps in order to distribute risk among their
affiliates. Thus, inter-affiliate swaps are an important part of
prudent risk management and a significant number of swap dealers and
other market participants engage in inter-affiliate swaps. This inter-
affiliate swaps activity is subject to a range of regulatory and other
controls.
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\71\ Based on a review of DDR data reflecting past use of the
Inter-affiliate Exemption, the Commission estimates that up to 70
eligible affiliate counterparties located outside of the United
States may elect to comply with one of the reinstated Alternative
Compliance Frameworks thereby choosing not to clear their outward-
facing swaps and rather to pay and collect variation margin on all
swaps with other eligible affiliated counterparties instead. These
70 entities include affiliates of swap dealers that are active in
multiple jurisdictions.
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In considering how the proposed rule would affect the protection of
market participants and the public, the Commission took into account
the value of inter-affiliate swaps as a risk management tool and the
extent to which the Alternative Compliance Frameworks would foster this
use of inter-affiliate swaps. The Commission also considered potential
increases in systemic risk if affiliates elect not to clear outward-
facing swaps and use the Alternative Compliance Frameworks instead. In
view of these factors, the Commission preliminarily believes that the
potential increases in systemic risk will be mitigated by the controls
on the use of inter-affiliate swaps, their inherent risk management
features, and the conditions set out in the proposed Alternative
Compliance Frameworks.
The proposed revisions also would create certain costs that would
be borne by entities electing the Inter-Affiliate Exemption. Under the
proposed revisions, entities that choose to comply with an Alternative
Compliance Framework would now be required to pay and collect variation
margin on their inter-affiliate swaps, which could be a significant
cost for those entities. However, the proposed revisions also provide
that an entity may continue to choose to clear an outward-facing swap
with an unaffiliated counterparty instead of paying and collecting
variation margin on all swaps with other eligible affiliate
counterparties. Therefore, affected entities are free to choose which
of these alternatives is best for them.
b. Efficiency, Competitiveness, and Financial Integrity of Swap Markets
The Commission preliminarily believes that the proposed revisions
to the Inter-Affiliate Exemption may have some, but not a significant,
impact on the efficiency or competiveness of swaps markets. As noted
above, inter-affiliate swaps are an important risk management tool for
affiliated corporate groups. To the extent that swap dealers may
participate more extensively in swap markets in non-U.S. jurisdictions
because they can use inter-affiliate swaps to manage risk efficiently,
the proposed amendments to the Inter-Affiliate Exemption may increase
the efficiency, competitiveness, and financial integrity of swap
markets by increasing the range of swaps that are available to market
participants. The Commission also preliminarily believes that the
revised Outward-Facing Swaps Condition and adoption of modified
Alternative Compliance Frameworks should discourage misuse of the
Inter-Affiliate Exemption. For example, the Commission recognizes that
internal calculations and swaps portfolio management is required to
comply with the five percent test under Commission regulation
50.52(b)(4)(iii). If the Commission had proposed to reinstate the
Alternative Compliance Frameworks, without adjusting the list of non-
U.S. jurisdictions in which an affiliated counterparty may be located
for purposes of Commission regulation 50.52(b)(4)(ii), entities may
have failed to appropriately calculate the permissible limits under the
five percent test under Commission regulation 50.52(b)(4)(iii).
Aligning the scope of jurisdictions included in the Alternative
Compliance Frameworks with the jurisdictions for which the domestic
currency is subject to the Commission's clearing requirement may help
to make these calculations and compliance with the provisions easier.
This should promote the financial integrity of swap markets and
financial markets as a whole.
c. Price Discovery
Under Commission regulation 43.2, a ``publicly reportable swap
transaction,'' means, among other things, any executed swap that is an
arms'-length transaction between two parties that results in a
corresponding change in the market risk position between the two
parties.\72\ The Commission does not consider non-arms'-length swaps as
swaps that contribute to price discovery in the markets, as they are
not publically reported, generally.\73\ Given that inter-affiliate
swaps as defined in this proposed rulemaking are usually not arms'-
length transactions, the Commission preliminarily believes that the
proposed revisions to the Inter-Affiliate Exemption would not have a
significant effect on price discovery.\74\ However, if the availability
of the Alternative Compliance Frameworks reduces the use of outward-
facing swaps, which may or may not be publicly reported depending on
the jurisdiction, there could be a negative
[[Page 70459]]
impact on price discovery when outward-facing swaps would otherwise be
publically reported.
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\72\ 17 CFR 43.2. See also Real-Time Public Reporting of Swap
Transaction Data, 77 FR 1182 (Jan. 9, 2012).
\73\ Transactions that fall outside the definition of ``publicly
reportable swap transaction''--that is, transactions that are not
arms-length--``do not serve the price discovery objective of CEA
section 2(a)(13)(B).'' Real-Time Public Reporting of Swap
Transaction Data, 77 FR at 1195. See also id. at 1187 (discussing
``Swaps Between Affiliates and Portfolio Compression Exercises'')
and Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR at 21780.
\74\ The definition of ``publicly reportable swap transaction''
identifies two examples of transactions that fall outside the
definition, including internal swaps between one-hundred percent
owned subsidiaries of the same parent entity. 17 CFR 43.2 (adopted
by Real-Time Public Reporting of Swap Transaction Data, 77 FR at
1244). The Commission notes that the list of examples is not
exhaustive.
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d. Sound Risk Management Practices
The conditions of the Inter-Affiliate Exemption do not eliminate
the possibility that risk may impact an entity, its affiliates, and
counterparties of those affiliates.\75\ Without clearing a swap to
mitigate the transmission of risk among affiliates, the risk that any
one affiliate takes on through its swap transactions, and any contagion
that may result through that risk, increases. This makes the risk
mitigation requirements for outward-facing swaps more important as risk
can be transferred more easily between affiliates.
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\75\ The Commission notes that even in the absence of required
clearing or margin requirements for swaps between certain affiliated
entities, such entities may choose to use initial and variation
margin to manage risks that could otherwise be transferred from one
affiliate to another. Similarly, third parties that have entered
into swaps with affiliates also may include variation margin
requirements in their swap agreements.
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Exempting certain inter-affiliate swaps from the clearing
requirement creates additional counterparty exposure for
affiliates.\76\ DCOs have many tools to mitigate risks. This increased
counterparty credit risk among affiliates may increase the likelihood
that a default of one affiliate could cause significant losses in other
affiliated entities. If the default causes other affiliated entities to
default, third parties that have entered into uncleared swaps or other
agreements with those entities also could be affected.
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\76\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21780-21781.
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In 2013, when the Commission finalized the Inter-Affiliate
Exemption, it assessed the risks of inter-affiliate swaps and stated
that the partial internalization of costs among affiliated entities,
combined with the documentation, risk management, reporting, and
treatment of outward-facing swaps requirements for electing the
exception, would mitigate some of the risks associated with uncleared
inter-affiliate swaps.\77\ However, the Commission indicated that these
mitigants are not a perfect substitute for the protections that would
otherwise be provided by clearing, or by a requirement to use more of
the risk management tools that a clearinghouse uses to mitigate
counterparty credit risk (i.e., both initial and variation margin, FCMs
monitoring credit risk of customers, clearing member contributions to
default funds, etc.).\78\
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\77\ Id.
\78\ Id. at 21778.
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e. Other Public Interest Considerations
The Commission has identified no other public interest
considerations.
D. General Request for Comment
The Commission invites information regarding whether and the extent
to which specific foreign requirement(s) may affect the costs and
benefits of the proposal, including information identifying the
relevant foreign requirement(s) and any monetary or other quantitative
estimates of the potential magnitude of those costs and benefits. The
Commission also requests comment on other aspects of the costs and
benefits relating to the proposed revisions to the Outward-Facing Swaps
Condition and Alternative Compliance Frameworks. The Commission
requests that commenters provide any data or other information that
would be useful in estimating the quantifiable costs and benefits of
this proposed rulemaking.
E. Antitrust Considerations
Section 15(b) of the Act requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the Act, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the Act.\79\ The Commission believes that the
public interest to be protected by the antitrust laws is generally to
protect competition. The Commission requests comment on whether the
proposal implicates any other specific public interest to be protected
by the antitrust laws.
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\79\ 7 U.S.C. 19(b).
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The Commission has considered the proposal to determine whether it
is anticompetitive and has preliminarily identified no anticompetitive
effects. The Commission requests comment on whether the proposal is
anticompetitive and, if it is, what the anticompetitive effects are.
Because the Commission has preliminarily determined that the
proposal is not anticompetitive and has no anticompetitive effects, the
Commission has not identified any less anticompetitive means of
achieving the purposes of the Act. The Commission requests comment on
whether there are less anticompetitive means of achieving the relevant
purposes of the Act that would otherwise be served by adopting the
proposal.
List of Subjects in 17 CFR Part 50
Business and industry, Clearing, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 50 as set forth below:
PART 50--CLEARING REQUIREMENT AND RELATED RULES
0
1. The authority citation for part 50 is revised to read as follows:
Authority: 7 U.S.C. 2(h), 6(c), and 7a-1 as amended by Pub. L.
111-203, 124 Stat. 1376.
0
2. Amend Sec. 50.52 as follows:
0
a. Revise paragraphs (a)(2)(i) and (ii);
0
b. Add paragraph (a)(2)(iii); and
0
c. Revise paragraph (b)(4).
The revisions and addition read as follows:
Sec. 50.52 Exemption for swaps between affiliates.
(a) * * *
(2) * * *
(i) A counterparty or third party directly or indirectly holds a
majority ownership interest if it directly or indirectly holds a
majority of the equity securities of an entity, or the right to receive
upon dissolution, or the contribution of, a majority of the capital of
a partnership;
(ii) The term ``eligible affiliate counterparty'' means an entity
that meets the requirements of this paragraph; and
(iii) The term ``United States'' means the United States of
America, its territories and possessions, any State of the United
States, and the District of Columbia.
(b) * * *
(4)(i) Subject to paragraphs (b)(4)(ii) and (iii) of this section,
each eligible affiliate counterparty that enters into a swap, which is
included in a class of swaps identified in Sec. 50.4, with an
unaffiliated counterparty shall:
(A) Comply with the requirements for clearing the swap in section
2(h) of the Act and this part;
(B) Comply with the requirements for clearing the swap under a
foreign jurisdiction's clearing mandate that is comparable, and
comprehensive but not necessarily identical, to the clearing
requirement of section 2(h) of the Act and this part, as determined by
the Commission;
(C) Comply with an exception or exemption under section 2(h)(7) of
the Act or this part;
(D) Comply with an exception or exemption under a foreign
jurisdiction's clearing mandate, provided that:
(1) The foreign jurisdiction's clearing mandate is comparable, and
[[Page 70460]]
comprehensive but not necessarily identical, to the clearing
requirement of section 2(h) of the Act and this part, as determined by
the Commission; and
(2) The foreign jurisdiction's exception or exemption is comparable
to an exception or exemption under section 2(h)(7) of the Act or this
part, as determined by the Commission; or
(E) Clear such swap through a registered derivatives clearing
organization or a clearing organization that is subject to supervision
by appropriate government authorities in the home country of the
clearing organization and has been assessed to be in compliance with
the Principles for Financial Market Infrastructures.
(ii) If one of the eligible affiliate counterparties is located in
Australia, Canada, the European Union, Hong Kong, Japan, Mexico,
Singapore, Switzerland, or the United Kingdom and each eligible
affiliate counterparty, or a third party that directly or indirectly
holds a majority interest in both eligible affiliate counterparties,
pays and collects full variation margin daily on all of the eligible
affiliate counterparties' swaps with other eligible affiliate
counterparties, the requirements of paragraph (b)(4)(i) of this section
shall be satisfied.
(iii) If an eligible affiliate counterparty located in the United
States enters into swaps, which are included in a class of swaps
identified in Sec. 50.4, with eligible affiliate counterparties
located in jurisdictions other than Australia, Canada, the European
Union, Hong Kong, Japan, Mexico, Singapore, Switzerland, the United
Kingdom, or the United States, and the aggregate notional value of such
swaps, which are included in a class of swaps identified in Sec. 50.4,
does not exceed five percent of the aggregate notional value of all
swaps, which are included in a class of swaps identified in Sec. 50.4,
in each instance the notional value as measured in U.S. dollar
equivalents and calculated for each calendar quarter, entered into by
the eligible affiliate counterparty located in the United States, then
the requirements of paragraph (b)(4)(i) of this section shall be
satisfied when each eligible affiliate counterparty, or a third party
that directly or indirectly holds a majority interest in both eligible
affiliate counterparties, pays and collects full variation margin daily
on all of the eligible affiliate counterparties' swaps with other
eligible affiliate counterparties.
* * * * *
Issued in Washington, DC, on December 12, 2019, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
NOTE: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Exemption From the Swap Clearing Requirement for Certain
Affiliated Entities--Alternative Compliance Frameworks for Anti-
Evasionary Measures--Commission Voting Summary and Commissioner's
Statement
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No Commissioner
voted in the negative.
Appendix 2--Supporting Statement of Commissioner Brian D. Quintenz
I support today's proposal to codify how affiliated swap
counterparties have, for the past six years, complied with an
important provision of one of the Commission's exemptions from the
swap clearing requirement. The Commission's swap clearing
requirement has accomplished the important task of requiring
financial institutions to centrally clear the overwhelming majority
of the most commonly-traded interest rate swaps and credit default
swaps through CFTC-supervised clearing organizations. According to a
Financial Stability Board (FSB) report published in October, at
least 80% of interest rate swaps and credit default swaps executed
in the U.S. are now cleared.\1\ Central clearing, through the
posting of initial and variation margin with a clearinghouse, has
greatly reduced counterparty credit risk in the swaps market,
helping to support confidence in the financial markets. However,
carefully considered exceptions should ensure that uncleared
products remain economically viable to provide market participants
with flexibility in managing risks. For example, entities belonging
to the same corporate group regularly execute swaps for internal
risk management purposes, and these swaps do not incur the same
risks as those executed with unaffiliated counterparties.\2\ The
Commission has also created exceptions to the swap clearing
requirement for commercial end-users, financial institutions
organized as cooperatives, and banks with assets of $10 billion or
less. As an additional point, I look forward to the Commission
finalizing last year's proposed exemptions for bank holding
companies and savings and loan companies having consolidated assets
of $10 billion or less and for community development financial
institutions.
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\1\ FSB OTC Derivatives Market Reforms: 2019 Progress Report on
Implementation (Oct. 2019), (Appendix C, Table J), https://www.fsb.org/2019/10/otc-derivatives-market-reforms-2019-progress-report-on-implementation/.
\2\ See the Commission's original proposed inter-affiliate
exemption, Clearing Exemption for Swaps Between Affiliated Entities,
77 FR 50425, 50426-50427 (Aug. 21, 2012).
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I believe the proposal before the Commission today strikes an
appropriate balance between guarding against evasion, on the one
hand, and providing flexibility for cross-border swaps activity on
the other. When affiliated financial counterparties exchange
variation margin on all of their swaps with one another, on a
worldwide basis, the risk that a U.S. firm can amass a critical
amount of uncollateralized exposure abroad is greatly reduced. At
the same time, the proposal does not disadvantage U.S.-based
institutions competing with foreign institutions located in
jurisdictions whose swap clearing requirements are narrower in scope
than the Commission's. I believe that today's proposal functions
rationally with the Commission's rules for margining uncleared swaps
on a cross-border basis, including in the context of inter-affiliate
transactions, and I look forward to comments on this topic.
In addition, I note that today's proposal would simplify the
existing inter-affiliate exemption to reflect current market
practices and eliminate complicated provisions that may never have
been relied upon. I hope the Commission's next rulemakings similarly
rationalize rules so that industry's compliance becomes less
burdensome and costly.
Appendix 3--Concurring Statement of Commissioner Rostin Behnam
I respectfully concur with the Commodity Futures Trading
Commission's (the ``Commission'' or ``CFTC'') decision today to
issue proposed amendments to the exemption from the swap clearing
requirement for certain affiliated entities. The original inter-
affiliate exemption rule was issued by the Commission in 2013.\1\
Today's proposal reminds us both of how forward thinking the
Commission was in implementing the Dodd-Frank Act and the goals
envisioned at the 2009 G20 Pittsburgh Summit, and of how we need to
be thoughtful and willing to update our rule set when reality
differs from what we envisioned.
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\1\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21750 (Apr. 11, 2013).
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The impetus for today's proposal boils down to this. In some
respects, the world hasn't turned out quite the way the Commission
envisioned. When the Commission promulgated the inter-affiliate
exemption rule in 2013, the perhaps overly hopeful expectation was
that other jurisdictions would quickly follow our lead and adopt
swap clearing requirements in short order. While a number of
jurisdictions now have clearing mandates for certain swaps, some
non-U.S. jurisdictions are still in the process of adopting clearing
regimes, and some non-U.S. jurisdictions vary significantly from the
Commission's clearing requirement. While the expectation in 2013 was
that the Commission would issue comparability determinations for
non-U.S. jurisdictions with respect to the clearing requirement, to
date the Commission has not issued any comparability determinations.
[[Page 70461]]
Because the Commission in 2013 expected the world to quickly
follow with clearing mandates, it established a temporary
Alternative Compliance Framework for compliance with the Outward-
Facing Swaps Condition of the Inter-Affiliate Exemption.\2\ Since
that temporary Alternative Compliance Framework expired in 2014, the
Division of Clearing and Risk staff has issued a series of no-action
letters extending the Alternative Compliance Framework to provide
more time for global harmonization.\3\ Today, because the global
regulatory landscape has not turned out quite like we expected, the
Commission proposes to codify and make permanent the Alternative
Compliance Framework.
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\2\ The Outward-Facing Swaps Condition requires an eligible
affiliate counterparty relying on the Inter-Affiliate Exemption to
clear any swap covered by the CFTC's clearing requirement that is
entered into with an unaffiliated counterparty, unless the swap
qualifies for an exception or exemption from the clearing
requirement. Commission regulation 50.52(b)(4)(i).
\3\ CFTC Letter Nos. 14-25 (Mar. 6, 2014), 14-135 (Nov. 7,
2014), 15-63 (Nov. 17, 2015), 16-81 (Nov. 28, 2016), 16-84 (Dec. 15,
2016), and 17-66 (Dec. 14, 2017), all available at https://www.cftc.gov/LawRegulation/CFTCStaffLetters/index.htm.
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While I support today's proposal and believe that it represents
the best path forward to provide legal certainty to market
participants regarding the Outward-Facing Swaps Condition of the
Inter-Affiliate Exemption, there is one significant aspect of the
proposal that gives me pause. In the preamble to the 2013 rule, the
Commission stated that the Alternative Compliance Framework provided
for the Outward-Facing Swaps Condition is ``not equivalent to
clearing and would not mitigate potential losses between swap
counterparties in the same manner that clearing would.'' \4\ We
reiterate this in today's preamble, stating that ``[a]lthough paying
and collecting variation margin daily does not mitigate counterparty
credit risk to the same extent that central clearing does, the
Commission believes, as stated in the 2013 adopting release for the
Inter-Affiliate Exemption, that variation margin is an essential
risk management tool.'' Despite clearly stating that variation
margin does not mitigate counterparty credit risk to the same extent
as central clearing, we nonetheless are proposing to exempt certain
transactions from central clearing under the theory that variation
margin mitigates counterparty credit risk. This may be the right
result, but I want to be absolutely certain that we are not
injecting unnecessary risk into the system by exempting these
transactions from central clearing in the name of focusing on the
easiest, cheapest risk management tool. I encourage interested
parties to comment on whether the alternative compliance framework
that we propose to codify effectively mitigates counterparty credit
risk, and the differences in risk mitigation between the alternative
compliance framework and central clearing.
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\4\ Id. at 21765.
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In part, I am comfortable with the proposal because the existing
rule provides the Commission with the ability to monitor how the
exemption is working. Under Regulation 50.52(c) through (d), the
election of the Inter-Affiliate Exemption, as well as how the
requirements of the exemption are met, must be reported to a
Commission-registered swap data repository.\5\ Accordingly, the
Commission will have a window into which entities elect the
exemption, how many swaps are exempted, and how the requirements of
the exemption are met. In addition, the Commission retains its
special call, anti-fraud, and anti-evasion authorities, which should
enable it to discharge its regulatory responsibilities under the
CEA. I believe that the Commission should closely monitor SDR data
regarding the Inter-Affiliate Exemption going forward in order to be
certain that the exemption is not being used to evade central
clearing, and to ensure that the exemption is not adding unnecessary
and preventable risk to the system.
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\5\ Commission regulation 50.52(c) through (d).
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I thank staff for their thoughtful responses to my questions,
and for making edits that reflected comments and suggestions made by
me and my staff.
Appendix 4--Statement of Commissioner Dan M. Berkovitz
I support the proposed rule to make permanent the alternative
compliance frameworks for certain swaps between the foreign
affiliates of U.S. firms and their non-U.S. counterparties.\1\ The
proposed rule would make permanent, with modifications, anti-evasion
provisions for inter-affiliate swaps that the Commission originally
adopted in 2013, and then extended through staff no-action letters
that remain in effect today. The no-action letters require U.S.
firms and their foreign affiliates to exchange variation margin in
connection with swaps entered into by the foreign affiliate with
non-U.S. counterparties, where such swaps are subject to the
Commission's clearing requirement and there is no comparable and
comprehensive clearing regime in the foreign jurisdiction. The
proposed rule upholds the Dodd-Frank Act's clearing mandate, deters
evasion, and helps to protect against systemic risk to the U.S. from
swaps executed overseas by foreign affiliates.
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\1\ See 7 U.S.C. 2(h)(1), which provides that if the Commission
requires a swap to be cleared, then it shall be unlawful for a
person to enter into such swap unless it is submitted to a
registered derivatives clearing organization (``DCO'') or to a DCO
that is exempt from registration. Part 50 of the Commission's
regulations sets forth the classes of swaps required to be cleared,
as well as certain conditional exemptions to the clearing
requirement, including the exemption and conditions under
consideration in this proposal.
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The Commission's rules provide a limited, conditional exemption
from clearing for swaps between certain affiliate counterparties,
including U.S. firms and their foreign affiliates (``Inter-Affiliate
Exemption'').\2\ At the same time, through both regulation and no-
action relief, the Commission has implemented measures designed to
prevent U.S. firms from routing swaps through their foreign
affiliates to evade the Commission's clearing requirement for such
swaps. These anti-evasion provisions condition the Inter-Affiliate
Exemption such that foreign affiliates of U.S. firms must clear
their outward-facing swaps if such swaps are: (1) Subject to the
Commission's clearing requirement and (2) entered into with
unaffiliated counterparties in foreign jurisdictions (``Outward-
Facing Swaps Condition''). The Outward-Facing Swaps Condition allows
outward-facing swaps to be cleared pursuant to a comparable and
comprehensive foreign clearing regime, if available.
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\2\ The Commission has previously found that ``inter-affiliate
transactions provide an important risk management role within
corporate groups'' and that they may be beneficial to the group as a
whole if properly risk managed. See Clearing Exemption for Swaps
Between Certain Affiliated Entities, 78 FR 21750, 21754 (Apr. 11,
2013).
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In jurisdictions where the Commission has not made a
comparability determination, the alternative compliance frameworks
permit the foreign affiliate to exchange full, daily variation
margin for the swap with its U.S. affiliate or its non-U.S.
counterparty, rather than clearing the outward-facing swap. The
alternative compliance frameworks permit the foreign affiliate to
enter into swaps with non-U.S. counterparties in foreign
jurisdictions under the same terms and conditions as other non-U.S.
persons in those jurisdictions. They preserve the competitiveness of
the foreign affiliates of U.S. firms without presenting significant
risks to the U.S. affiliate or importing significant risks into the
U.S. Today's proposed rule would make the alternative compliance
frameworks permanent, with certain modifications.\3\
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\3\ The original alternative compliance frameworks expired in
2014, but have been repeatedly extended through no-action letters
that expire in December 2020.
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I support the proposed rule's emphasis on clearing, anti-
evasion, and systemic risk by preserving the Outward-Facing Swaps
Condition and making permanent the alternative compliance
frameworks. The proposed rule would also expand the jurisdictions
subject to one of the alternative compliance frameworks to include
additional jurisdictions that have adopted and implemented their
respective domestic clearing mandates.\4\ By extending and making
permanent the alternative compliance frameworks, the proposed rule
would address the lack of comparability determinations for foreign
clearing regimes, while ensuring the continued operation of anti-
evasion and anti-systemic risk provisions in the Commission's rules.
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\4\ The proposed alternative compliance frameworks consist of
two distinct but similar sets of requirements. Both would require
the exchange of full, daily variation margin. However, the first
framework, in proposed Sec. 50.52(b)(4)(ii) would apply to eight
enumerated jurisdictions that have adopted domestic clearing
mandates. The second framework, in proposed Sec. 50.52(b)(4)(iii),
would apply in all other jurisdictions. Swaps in this second
framework would be limited to the ``five percent test,'' which
limits the uncleared swaps activity that a U.S. eligible affiliate
counterparty can transact with its affiliates in non-enumerated
jurisdictions. The five percent test was also present in the
alternative compliance frameworks when they were adopted in 2013.
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The proposed rule seeks public comment on whether the
alternative compliance frameworks are sufficient to address
potential
[[Page 70462]]
systemic risk to the U.S. and whether they may produce a permanent
residual class of swaps that are not cleared but instead result in
the exchange of variation margin between eligible affiliate
counterparties (and the risks associated with those swaps). I look
forward to public comments on these questions and other aspects of
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the proposal.
[FR Doc. 2019-27207 Filed 12-20-19; 8:45 am]
BILLING CODE 6351-01-P